Israel.
Economic Data
• Last week, the Ministry of Finance’s and the International Monetary Fund’s updated growth forecasts for Israel for 2021 were published. The Ministry of Finance expects the optimistic scenario to grow by 4.6%. In contrast, the IMF expects only 4.1%. Both forecasts are significantly lower than the Bank of Israel’s optimistic forecast of 6.3%.
• The broad aggregate of money (M3) has risen by 23.4% in the past year, the highest rate since the mid-1990s. Of the total increase of NIS 285 billion, about 95% constitute current account balances and deposits in shekels and foreign currency for a period of up to one year.
As can be seen in Figure 2, in the last decade there has been a relationship between the rate of change in the M3 and the change in the price index (excluding energy and government reductions) with a lag of about a year and a half. It should be noted that in previous decades the relationship was tighter and more immediate.
Reaching short returns to zero and even negativity reflects a turning point
Interest rates in Israel have not changed, but yields on fixed-income bonds and short-term shekel bonds have recently fallen to zero and even below them. This development is probably not due to expectations of lowering the Bank of Israel’s interest rates, but to demands from foreign investors in foreign exchange swaps (Fx swap). The attractiveness of these transactions in Israel is higher than in other countries due to a significantly lower base swap than in Europe, Japan or the UK.
Although seemingly a decrease in returns from 0.1% or 0.2% to zero is not so significant, the very reset of the return on a safe investment creates a significant movement of funds. In the last three months alone, about NIS 2 billion has come out of the monetary funds and government bond funds, compared with a strong flow to risky channels.
Experience in Europe shows that this is a significant event for the markets. The excess return achieved by equities and HY bonds in Europe over the US counterparts in 3 months after lowering interest rates to 0%, was significantly higher than after any other interest rate cut in those years, including to negative levels.
How will resetting short-term returns affect other channels?
First of all, demand for long-term bonds is expected to increase. Until interest rates in Europe fell to zero, the steepness of the German curve reacted to a change in interest rates in a standard way – rising when interest rates fell and falling when interest rates rose.
We do not expect interest rates in Israel to fall to zero or negative, but the decline in short-term yields to these levels is already increasing demand for long-term bonds. The yield curve structure in Israel raises the attractiveness of the transition. It is much steeper.
Recently, there has been an increase in demand for government bond issues, especially long-term ones, as reflected in the increase in the coverage ratio. In our opinion, this process is related, among other things, to the reset of short and medium yields.
It is also possible that some of the demand for index-linked bonds, which fuels rising inflation expectations, stems from the same reason. Investors prefer a “contract” over the price index over a safe zero return.
The potential for the funds to exit the short-term channels is still great, especially from the public. At the end of December, the funds had about NIS 15 billion. In government bonds and shekel bonds, some of which are invested in short-term shekel channels, there were about NIS 40 billion.
The Bottom Line: We recommend a medium maturity using the long and short-term shekel bonds.
In the corporate channel the margins, yields and time premium at the bottom
The spreads in A-class corporate bonds in Israel have fallen to almost the lowest levels since the 2008 crisis. However, in the AA group the spreads have not yet reached the bottom, except in the AA + group.
Yields to maturity are also at the lowest level ever. The average yield to maturity in rating A stands at only 1.75%.
In addition, the gap between the spreads of long-term and short-term corporate bonds is very small. Investors receive very low compensation for taking credit risk which under normal circumstances increases significantly as the investment range recedes.
A low level of spreads alone will not prevent continued flow of funds into the corporate channel when the government bond alternative yields a near-zero return. However, the ratio of return to risk in a risk-matching channel gives preference to equity risk in this situation to the equity channel.
The Bottom Line: A conservative approach to the corporate channel is recommended, focusing on high ratings and short-term medium-term hedges. It is better to increase risk through the equity channel.
world.
The industrial activity is strong, the services industry is expected to join after the medical risk reduction
Despite the epidemic, the Purchasing Managers ‘Index for January in the US was a pleasant surprise. Overall, manufacturing activity continued to expand in Europe and the US. Expansion even accelerated. Even in the UK, Purchasing Managers’ Index rose sharply. Improvement in the purchasing managers’ index in the American services sector, which rose from 54.8 to 57.5, while in Europe the index actually fell to 45.
Over the years there has been a very high correlation between the Purchasing Managers’ Indices indices and the services in the US and Europe. Thus, the intensity of industrial activity during this period indicates that the services sector is also expected to recover rapidly after the reduction of medical risk.
Will the Fed panic?
At the Fed meeting this week, the existing policy is not expected to change, but important messages may emerge from it. Although Governor Powell has recently said that there is no point in even discussing a reduction in purchases at this stage, his statement may be insufficient and should be reinforced in the Monetary Committee’s message, especially given the prospect of approving another incentive plan.
Until a few years ago there was no chance of getting Fed support in similar circumstances. Inflation expectations for two years have risen by about 0.6% since its last meeting in December and reached 2.5%, for the first time since 2011. Expectations for 5 years have risen by about 0.3% to a level of 2.2%. The steepness of the American yield curve between 5 and 10 years has risen to the highest level since 2015.
The current Fed has a much calmer approach to inflation risk should not be alarmed by this, but it is possible that the “old instincts” of the Fed governors will arise, some of whom have already begun to talk recently about reducing purchases. If the Fed casts a small shadow of a doubt on its willingness to continue to support markets, as the ECB Governor almost did at a press conference after last week’s interest rate decision, it could cause shock, not only to the bond market but also to equities.
The Bottom Line: We estimate that at its meeting this week the Fed will continue to send messages about its support for the economy without reservation, but recent developments still raise a chance for surprise.
Is the stock market a bubble?
Stock markets continue a positive trend despite severe morbidity, vaccination disappointments and lukewarm economic data. Investors fear bubble inflating. The number of searches for the word “market bubble” in Google in January was at its highest level since 2006. Is there really a bubble in the stock market? In our opinion, the chances are not and these are the reasons for this:
1. An improvement in the economic data that will support the markets will soon be felt
At the forefront of the epidemic is a decline in the number of new patients, more so in the US and less so in Europe. Although the immunization process is in its early stages, it is beginning to gain momentum in various countries.
The common perception is that the change will only be felt when the immunization rate reaches at least 60%, which is expected to happen in most developed countries only in the second half of the year. However, in order for the economic data to start improving, you do not have to wait until then. The change in economic activity will soon be felt. An increase in immunization, especially among the elderly, will lead to a decrease in severe morbidity, which should not only alleviate regulatory constraints, but also reduce concerns among the general public and increase consumption and other economic activity.
As in exiting an economic recession, progress from a recession to growth does not occur in a sharp transition, but in a gradual one. However, in terms of markets it will be enough to feel more confident.
2. A real “game changer” is not the central banks, but the governments
The argument that is often heard is that increases in markets rely exclusively on the activities of central banks. Although the contribution of central banks is important, in our opinion it is not the main reason for the increases. The central banks were indeed the decisive factor in stopping the declines at the height of the crisis in March and April. Since then, the rate of their purchases has dropped and is not particularly unusual.
The growth rate of the Fed balance sheet over the past six months has not been higher than that of QE waves in the previous decade. The activity of the BOJ is not unusual either. The ECB’s purchases are indeed large, but it is precisely the European stock market that is showing weakness relative to the other markets.
The real “game changer” is not the central banks, but the fiscal incentives. Their scale exceeds those of those triggered by the crisis in 2008 in all major countries (in the US we assumed that only half of the plan proposed by the new president would be approved). The incentives are not only absolute, but also much larger in terms of hurting the economy.
The impact of fiscal incentives on economic activity is greater than central bank acquisitions, and is expected to lead to accelerated growth in the second half of the year.
3. The crisis has caused a leap in corporate efficiency that is expected to be reflected in profitability
In the current crisis, there has been a leap forward in the streamlining of companies, mainly through investments in technology that is expected to lead to an increase in productivity and profitability. Unlike previous crises, American companies have hardly taken down purchases of investment products, mainly of technology products. Over the past few decades the purchase of investment products has been an indicator of a high correlation with the behavior of the stock market.
4. The market is not cheap, but not at the dangerous end
Investors fear that the market is already very expensive and has lost touch with economic reality. Indeed there are properties with excessive and bubble pricing. Overall, however, the future earnings multiplier of the S&P 500 at equal weight is no different today than at the exit from the previous three recessions in the US. It should be noted that interest rates today are much lower and justify higher profit multipliers both because of comparison to other alternatives and because of higher current value of future profits.
5. Indeed, there is a lot of optimism, but it is not excessive
Another concern stems from over-optimism from investors, economists and analysts. Excessive optimism is indeed usually not a good sign for the future of the markets. However, in the US private investor survey, the percentage of “bullish” investors is not excessive and is at a level where the S&P 500 generally presented a positive return on average six months later. Even according to the current institutional investor sentiment index, the future return expectation is positive.
6. Stock exposure is not at its peak
Finally, it should be noted that the exposure of American households to the equity channel and mutual funds together as the rate of their total financial assets is indeed at an all-time high, but American pension funds are far from the peak. Financial entities have also been in the past with greater exposures. Given the current level of interest rates, which reflect an alternative to investing in equities, the weight of equities in portfolios is expected to increase.