Super-Rally in Tel Aviv: Potential profit vs. potential risk

Israel Leading Indices for the past year: TA-25 (w (photo credit: none)
Israel Leading Indices for the past year: TA-25 (w
(photo credit: none)
The domestic stock market's investors has enjoyed 2consecutive quarters of positive returns. In fact, the Israeli equitymarket bottomed in the end of November, and almost since then was on asharp takeoff. The main index Tel Aviv 25 increased by 63%, Tel-Tech 15rose 79%, the Banking Index doubled its value, and the Real EstateIndex advanced the most - 150%. This ride has been supported bycontinuous increases in trading volume which recently averaged ILS 2.3billion, compared to an average of ILS 1.5 billion since the beginningof the year.
Several parameters support this powerful trend:first and most important is the aggressive stimulative policy of BoIand other major central banks - mainly by slashing rates close to zeroand increase money supply. Second, Israel recession is on track to endprobably in the last quarter of 2009, supported by financially strongconsumers and international trade revival. The US and global recessionsare also on the same path and it certainly supports the public optimismand foreign investors' sentiment. Consequently, institutional investorsaround the world keep allocating more cash toward stocks after facingincreasing pressure to commit funds to the market in order tryoffsetting the losses from 2008. Thus, stock prices may rise evenfurther and sharper in the coming months.
However, alongside the positive trend, investors should becautious in implementing a higher-risk investment strategy. There arestill many reasons to be concerned about the economic outlook, bothfrom a short-term and long-term perspective, and an additional U-turnin the real economy will change investors' optimism and preferencestoward high-risk financial assets.
The crawling out of recession will not be short and smooth.There are several growth obstacles such as regulation, creditdeleveraging, continuous decrease in production, increasingunemployment, and future contractionary fiscal policy. Additionally, anaggressive interest rate increases due to a potential inflationoutbreak may paralyze demand for stocks and cause a selling pressure inthe domestic market.
The cost of living rose by an annual rate of 3.6% inthe month of June. The overall inflation of July-August should grow by1%-1.5% according to various forecasts. At the same time, inflationexpectations that are derived from the government bond market went upsharply in recent months. Today, the bond market prices 4% inflation inthe 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 8years. Consequently, the zero-coupon bond market (Makam) prices aninterest rate increase of 50 basis points by the end of the year, and100 basis points by the end of the first quarter in 2010. If the BoIwill start increasing rates aggressively accordingly to marketexpectations the demand for stocks may dry up and a temporary sellingpressure may occur.
Bottom line, the combination of pro-growth policies and aneconomic revival have increased investor optimism. Momentum is helpedby international stock markets, mainly from the financial district ofNew-York which dictates the tone of the global markets. Also,institutional investors and private ones who have been underweightequities continues to allocate more cash toward equities, in order tonot miss the opportunities for gains and to offset the losses from thelast brutal bear market. These factors increase the likelihood ofadditional gains in the financial markets in the short run. Despite therecent optimism, investor should be cautious, especially because of theforceful rally since the beginning of the year in Tel-Aviv. Inaddition, the mid-long term economic outlook still consists of bleakelements and uncertainties, especially in the case of the developedeconomies in which we are heavily dependent on. As a result, the stockmarket may be affected negatively by the potential future developmentsand 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

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