Significant erosion in export profitability due to the strengthening of the shekel

highlights

Early immunization in Israel will increase growth relative to most other countries, which may add pressure to the strengthening of the shekel and support the local stock market.

• The business sector reports a significant erosion in export profitability following the strengthening of the shekel. In particular, exports from the services sector were particularly affected compared with previous years.

• The Bank of Israel will probably not continue to purchase corporate bonds as long as margins remain low.

The examination shows that most of the purchases of government bonds by the Bank of Israel were in the range of more than 10 years with a bias in shekel bonds. This year it purchased longer bonds than the Ministry of Finance issued. This activity may support the flattening of the yield curve in its long run.

• The increase in the price of agricultural goods in the world is expected to lead to an increase in food prices in Israel.

• The new US $ 4 trillion economic investment plans, mostly in infrastructure, are expected to support shares in the infrastructure, industry, health and cyclical consumption sectors.

• An upward trend in long-term bond yields and US inflation expectations is expected to moderate at this point.

Highlights:

• We continue to recommend overweight exposure to Asian stocks.
• We recommend reducing exposure to corporate bonds in Israel and prefer to increase equity exposure.

Israel

Early immunization will increase the rate of growth and may support the local stock market
In the Bank of Israel’s optimistic forecast for growth of 6.3% in 2021, as published last week, the population was expected to be vaccinated by May. The advance to March, as announced by the Prime Minister, is expected to increase the growth rate in 2021 to a higher rate of about 7%. Inflation is also expected to be affected by an earlier than expected removal of the restrictions.

Israel’s economy is expected to open a large gap with most other countries. According to the World Bank’s forecast published last week, most of the world is expected to reach a vaccination rate of about 60% in the third quarter of this year alone (Chart 2). An early recovery of the Israeli economy may add pressure to the strengthening of the shekel and support the local stock market.

The strengthening of the shekel erodes export profitability, also in the services sector
Some interesting insights can be learned from the CBS Business Trend Assessment Survey for December:
• Although the Bank of Israel purchased a record $ 4.4 billion in December, the shekel continued to strengthen and hurt Israeli exporters. According to the results of the survey, the severity of the restriction related to the erosion of export profitability reached a level similar to that in the manufacturing sector in 2017-18, when the shekel fell from NIS 3.8 to the dollar to NIS 3.4-3.5 (Figure 3).

In the services sector, the limitation is as severe as it has ever been. Most of the sector’s exports come from the activities of high-tech companies. The strengthening of the shekel increases workers’ costs compared to other countries and impairs the viability of investments in Israel. As can be seen in Figure 4, the average salary in the US technology industry has risen by about 19% since 2012, while in Israel the increase was about 57%, of which the strengthening dollar is responsible for about 14%. According to the DAXX website, the average salary in engineers’ dollars The computer in Israel is the third tallest in the world, according to a survey published in March.

• Despite the strengthening of the shekel, manufacturing companies reported in the survey a significant easing of the limit on the shortage of export orders in recent months (Chart 5) and an expected increase in orders, probably against the background of an increase in world foreign trade.
• Manufacturing companies reported expectations of a significant increase in the prices of finished products (Figure 6).

Increase in household savings

Total household income in Israel, including transfer payments and grants, increased from the beginning of the year to the end of October by about 3% compared with the corresponding period last year (Figure 7). In contrast, private consumption fell by about 10%. For comparison, in 2019, total household income increased by about 6.5%, while private consumption increased by about 4.5%. These data show that households have accumulated significant savings this year. The accumulated surpluses will be directed to private consumption and will be one of the main engines that will support the recovery of the economy.

The Bank of Israel mainly buys the very long bonds with a bias in shekels
In December, the Bank of Israel purchased government bonds in the amount of NIS 4.6 billion, similar to the previous month. It did not buy anything in the corporate market. Given the very low margins, the Bank of Israel will probably refrain from purchasing corporate bonds in the future, unless Will change for the worse.

From the monthly data of government bond purchases and the value of the Bank of Israel’s holding in the channel (data from the Bank of Israel’s website), the monthly yield of its portfolio can be deduced and compared to the change in various bond prices during that period.
Chart 8 shows that the highest correlation exists between the performance of the Bank of Israel’s bond portfolio and the longest securities, especially with the shekel bonds (142, 347). Therefore, the Bank of Israel mainly buys long-term bonds over 10 years with a higher weight for shekel bonds.

Several conclusions can be drawn from this:

• Unlike the large central banks that purchase bonds in the vicinity of the market maturity or even less, the Bank of Israel mainly buys securities whose maturity is much higher than the tradable market maturity (about 7.3 years) and also the average maturity of government mobilizations. In the tradable market last year, which stood at about 6.6 years, therefore, the purpose of the Bank of Israel’s acquisitions is not only classical quantitative easing, but also to prevent the rise in long-term yields.In these ranges, the government mainly recruits.

Last year, the Ministry of Finance raised about NIS 40 billion in the tradable market in bonds for periods of 10 years or more out of the total raised, which amounted to about NIS 131 billion. The Bank of Israel purchased bonds for about NIS 46.2 billion, most of them for the long term. From 10. In principle, there was supposed to be a shortage of long-term bonds justifying crooked flattening, which did not happen in practice.

A rise in world agricultural commodity prices is expected to lead to rising food prices in Israel

Since the beginning of May, the prices of agricultural goods have risen by about 40% in dollars and by about 30% in shekel terms. In the first decade of the century, the rise in agricultural commodity prices has always translated into a rise in food prices in Israel (Figure 10). In the last decade, the trend has reversed and agricultural commodity prices have declined, but without affecting a corresponding decline in food prices in Israel, but only in price stability. Now, if the rise in the prices of agricultural goods continues, there is a pretty high chance that it will translate into a rise in food prices in Israel.

world.

The American economy is about to receive a significant boost from the implementation of the new administration’s plans
Democrat control of the U.S. in both houses of parliament raises the prospect of realizing the new president’s economic plan that includes massive investment in the U.S. economy in the coming years.
The investment plan is expected to total about $ 4 trillion during the years 2021-24 (not including the incentives that the incoming president plans to transfer in the near future) with 60% of it (about $ 2.3 trillion) directed to infrastructure investment, including investments in transportation infrastructure, Made in America program “Of investments in industry, clean energy, etc.

An amount of about $ 600 billion will be invested in education and a similar amount in the health care system (Figure 11). The expenses are expected to be financed by raising taxes in the amount of about $ 1.4 trillion, mainly on the rich companies and households. The rest of the financing will rely on increasing the budget deficit that is expected to bring the debt-to-GDP ratio to about 120% in four years.

Because of the expected tax increase, this program may not be the most stock market friendly, but is expected to do very well with the U.S. economy (we learned this year that the stock market and economy are not always the same) and American society. Ultimately, investment in infrastructure and education increases long-term growth potential.

Despite the tax hikes that could hurt stock performance, the planned economic measures establish more stable support in the stock market than the fragile infrastructure that central bank measures alone provide. The implementation of the programs is expected to benefit mainly with companies operating within the US (so Russell’s surplus performance is expected to continue). The infrastructure, industry, health and education services and investments in climate conservation will be given priority. The private, especially the cyclical.

In our opinion, the recent jump in bank shares will be temporary due to the limited potential for rising bond yields and due to the risk of increased regulation in the industry.
Although the technology sector may suffer from regulatory tightening, the acceleration in technological development during the epidemic and the continuation of the technological revolution that is expected to peak in the next decade is expected to support the sector’s shares.

In the short term, the positive news is expected to subside. Global economic data is weakening against the backdrop of a powerful wave of morbidity, which may add to market volatility. The continued rise in yields in the bond market may also interfere with equities, although it is still at a very low level, with corporate bond yields close to the lowest levels ever.

Overall, we anticipate a positive stock market this year should a health risk decline scenario materialize. A future S & P500 profit weight multiplier is found at relatively high levels, but is no exception compared to other periods after exiting any of the recessions in recent decades, especially against interest rates The low prevailing now (Figure 12).

The Bottom Line: We continue to recommend medium-high exposure to the equity channel.

Rising bond yields and inflation expectations are expected to be limited at this point

A mirror image of stock increases against the backdrop of the new administration’s plans was a rise in long-term bond yields, and a rise in implied inflation expectations. , But in our estimation we do not see it continuing at a recent pace due to several reasons:

The US Treasury’s net fundraising, net of Fed acquisitions, is expected to reach an all-time high of about $ 2 trillion this year, even before increasing the immediate incentives promised by the new president (Figure 14). Make the Fed increase purchases. As long as there is no significant inflationary threat, the new finance minister, who was the Fed governor and the acting governor are expected to cooperate so as not to hurt the administration’s economic plans.

• The foreign exchange reserves of the world central banks are growing rapidly due to the strengthening of their currencies, leading to an increase in demand for US government bonds. In the last two months alone, they have purchased bonds worth about $ 80 billion.

• Demand from other overseas investors for U.S. bonds is also expected to increase following an increase in the gap between the yield of currency-protected U.S. bonds and domestic bonds in Japan and Europe to the high levels of recent years (Chart 15).

• The relatively sharp steepness of the curve (30Y / 5Y) that has reached the highest level in the last five years may make long-term bonds attractive to American investors as well (Chart 18).

• In the debate between MMA risk and credit risk, the advantage of taking MMM risk arose after, for the first time since 2014, the 30-year government bond yield exceeded the investment grade of corporate bonds (Chart 17).

Inflation threats are indeed reflected in various indicators, such as the price component in the purchasing managers’ indices (Figure 19), rising transport costs (Figure 20), rising commodity prices and more. In our view, inflation is indeed expected to increase after the corona crisis, but this should not happen until health restrictions are lifted.

• It is worth noting that at this stage, rising inflation is a unique American phenomenon. Only in the United States has the rise in the price index in the last six months been higher than in the same period in recent years (Figure 16). This situation indicates that this is not a broad phenomenon that is actually related to the plague.

• Meanwhile, the nature of inflation in the US is very unique. An increase in inflation is due solely to the rise in commodity prices, with services prices, which generally constitute a stable core of inflation, actually declining (Figure 21). Temporary supply and the weakening of the dollar In order for inflation to rise to be stable and consistent, it must also be reflected in services prices, which we expect to happen in 2022.

An increase in US inflation expectations is closely related to commodity prices (Chart 22). They in turn are closely related to the weakening dollar, which we believe is mainly due to increases in the stock market.

Bottom line: We estimate that at this stage there may be a moderation in the continued rise in bond yields. We continue to recommend a medium-term CPI in the bond component by holding longer and shorter-term shekel bonds.