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The domestic stock market's investors has enjoyed 2 consecutive quarters of positive returns. In fact, the Israeli equity market bottomed in the end of November, and almost since then was on a sharp takeoff. The main index Tel Aviv 25 increased by 63%, Tel-Tech 15 rose 79%, the Banking Index doubled its value, and the Real Estate Index advanced the most - 150%. This ride has been supported by continuous increases in trading volume which recently averaged ILS 2.3 billion, compared to an average of ILS 1.5 billion since the beginning of the year.
Several parameters support this powerful trend: first and most important is the aggressive stimulative policy of BoI and other major central banks - mainly by slashing rates close to zero and increase money supply. Second, Israel recession is on track to end probably in the last quarter of 2009, supported by financially strong consumers and international trade revival. The US and global recessions are also on the same path and it certainly supports the public optimism and foreign investors' sentiment. Consequently, institutional investors around the world keep allocating more cash toward stocks after facing increasing pressure to commit funds to the market in order try offsetting the losses from 2008. Thus, stock prices may rise even further and sharper in the coming months.
However, alongside the positive trend, investors should be cautious in implementing a higher-risk investment strategy. There are still many reasons to be concerned about the economic outlook, both from a short-term and long-term perspective, and an additional U-turn in the real economy will change investors' optimism and preferences toward high-risk financial assets.
The crawling out of recession will not be short and smooth. There are several growth obstacles such as regulation, credit deleveraging, continuous decrease in production, increasing unemployment, and future contractionary fiscal policy. Additionally, an aggressive interest rate increases due to a potential inflation outbreak may paralyze demand for stocks and cause a selling pressure in the domestic market.
The cost of living rose by an annual rate of 3.6% in the month of June. The overall inflation of July-August should grow by 1%-1.5% according to various forecasts. At the same time, inflation expectations that are derived from the government bond market went up sharply in recent months. Today, the bond market prices 4% inflation in the next 12 months where the inflation target range of BoI is 1% to 3%. Also, the market prices more than 3% annual inflation in the next 8 years. Consequently, the zero-coupon bond market (Makam) prices an interest rate increase of 50 basis points by the end of the year, and 100 basis points by the end of the first quarter in 2010. If the BoI will start increasing rates aggressively accordingly to market expectations the demand for stocks may dry up and a temporary selling pressure may occur.
Bottom line, the combination of pro-growth policies and an economic revival have increased investor optimism. Momentum is helped by international stock markets, mainly from the financial district of New-York which dictates the tone of the global markets. Also, institutional investors and private ones who have been underweight equities continues to allocate more cash toward equities, in order to not miss the opportunities for gains and to offset the losses from the last brutal bear market. These factors increase the likelihood of additional gains in the financial markets in the short run. Despite the recent optimism, investor should be cautious, especially because of the forceful rally since the beginning of the year in Tel-Aviv. In addition, the mid-long term economic outlook still consists of bleak elements and uncertainties, especially in the case of the developed economies in which we are heavily dependent on. As a result, the stock market may be affected negatively by the potential future developments and thus investors should not be over exposed to high risk assets.
The writer is Chief Analyst and Strategist at Alumot-Sprint Investment House and also a regular writer for several leading financial papers and Web sites