highlights
Current indicators indicate a continued expansion in private consumption in the economy.
Total wages in the economy have almost closed the gap with the pre-epidemic trend.
A low rate of problem credit in banks indicates a relatively good financial situation of households and companies.
Bond yields in Israel have fallen sharply in the past month in the world.
Foreign investors continued to buy shares in Israel in the third quarter as well.
The rising morbidity in Europe has not yet hit economic activity, as it has in previous waves.
The American economy continues to grow at a very fast pace.
In the last month inflation has risen above forecasts in all countries in Asia and Europe.
In our view, the markets are exaggerating the potential harm of a change in Fed policy in the economy on the one hand, and the ability to raise interest rates as it is meant to suppress inflation on the other.
Israel.
Demand continued to grow even after the holidays
The recovery in the economy also continued in October. Credit card purchases were significantly higher than the trend in recent months (Chart 1), with spending on services returning to a multi-year trend (Chart 2).
Total wages in the economy recover much faster than jobs
Average wage data in the economy are still distorted due to the excessive effect of changes in the number and composition of jobs. It is also worth waiting for the data for the month of October, when there was a sharp drop in unemployment, which is expected to be reflected in the data on wages and jobs.
The total wage paid in the economy, which ultimately defines the purchasing power of consumers, is very close to closing the gap compared to the trend (Figure 3), with a number of jobs still far from it (Figure 4).
A decrease in problem credit indicates the nature of the financial situation in the economy
The bank credit data published by the Bank of Israel reflect a continued rapid increase in commercial credit and housing loans.
Nearly 60% of all the increase in commercial credit in the past year has been to companies in the construction and real estate industry. (Figure 6).
In the case of credit to households, the problematic credit rate is also on a downward trend, especially with a decrease in the mortgage sector (Figure 5).
Overall, the decline in problem debt indicates an improvement in the financial condition of households and companies.
The decline in bond yields in Israel was the sharpest in the world
In the domestic bond market, there has been a sharp decline in shekel bond yields in the past month, especially in the middle of the curve (Chart 7) and inflation expectations (Chart 8).
Even before the effect of the decline in world yields over the weekend, the decline in 5- and 10-year bond yields in Israel in the past month was the sharpest of any country in the world (Figure 9-10). It is difficult to find an economic justification (Travel abroad) and even in the exchange rate of the shekel in the last month only closed the top ten of the strongest currencies in the world.
It makes sense to expect that a rise in inflation far above forecasts in most countries in the world will not miss inflation in Israel either, as a change in the Fed’s policy raises the chance of a rise in interest rates here.
The Bottom Line: In light of our estimates of interest rates and inflation, the current level of yields reflects a particularly unattractive risk-to-equity ratio. We recommend shortening the length of the bag. We recommend tilting the adjacent bus.
Foreigners continue to buy shares in Israel
Foreign investors continued to inject money into the Israeli stock market also in the third quarter with purchases of close to $ 1 billion. In total, since the beginning of the year, they have bought shares in Israel for about $ 2.8 billion after a two-year absence from the local market (Figure 11).
world.
The current wave of morbidity has so far not significantly affected economic activity
Meanwhile, despite a sharp rise in the number of patients mainly in Europe, the indicators of world economic activity in November were not significantly affected. Previous waves of morbidity have had a greater impact on global purchasing managers’ indices, particularly in the services sector (Figure 12).
Europe – meanwhile holds up against a wave of morbidity
Despite a significant increase in morbidity, meanwhile, there has been no significant slowdown in activity in Europe:
Industry continued to expand in November at a rate similar to the previous two months (Figure 14). Most surprising was an improvement in the services sector (Figure 15).
The unemployment rate fell in October to 7.3% below the pre-epidemic level of 7.5%.
Sentiment indices in the various sectors remained fairly stable in November (Chart 13).
Inflation in Europe continues to soar
Inflation data in Europe continued to be surprising and broadly after rising from 4.1% in October to 4.9% in November and from 2.0% to 2.6% in core inflation (Chart 16). The rate of increase in the producer price index rose from 16.1% to 21.9% (!) In October (Figure 17). In our view, the ECB is also on track to put the word “transitory” out of use.
Asia – Activity is expanding, inflation is rising faster than forecast
Asian economies continue to recover as indicated by Purchasing Managers’ indices in manufacturing in all countries except China higher than 50 (Figure 18). Exports are growing at a significantly higher rate than before the plague (Figure 19).
It should be noted that in Asia, too, the price indices published in Singapore, Malaysia, Vietnam, Indonesia, Thailand and Korea were higher than forecast.
USA – The economy is growing rapidly
The US economy has shown good results in recent months. Although the number of new jobs added in November was lower than forecast, in our view this does not indicate a weakness in the labor market. If there is already a problem, then it is probably related to a shortage of workers. This can be learned from a variety of other indicators:
The Fed’s Beige book published last week found that employment was growing at a “medium-strong” rate compared to a “moderate-moderate” in the previous October report.
A record number of workers who were not among job seekers began working in November (Figure 21).
The employment rate continued to rise, with the unemployment rate falling to 4.2%, much higher than forecast and almost closing the gap compared to the pre-crisis level (Figure 20).
Other U.S. data also suggest the economy is expanding “on steroids.” ISM purchasing managers’ indices in the services sector have climbed to an all-time high. The manufacturing index is also at high levels (Chart 22). Companies continue to make investments on an unprecedented scale (Chart 23).
According to GDP Now, the US economy is expected to grow in the fourth quarter at a high rate of 9.7%.
Markets reflect that rising interest rates will hurt growth and lower inflation
The turnaround the Fed Governor made in addressing inflation should not have come as a surprise. A central bank operating out of rational considerations had no choice. According to forecasts, the inflation rate is expected to rise to 6.7% in November and of core inflation to 4.9%. This is not the level of inflation that the central bank can tolerate. The Fed is expected to accelerate the reduction in purchases and under the contracts to make three interest rate hikes by the end of next year.
The steepness of the US yield curve between 5 and 30 years dropped to a level of 0.54%, a level that in the previous interest rate hike cycle reached only when the Fed interest rate had already risen to 1.5% (Chart 24). At this rate the curve can still be reversed before the Fed raises interest rates even once. It looks like an exaggerated script.
The declines in equities and bond yields reflect a relatively modest rise in interest rates that will be enough to hurt growth and suppress inflation. This scenario is possible, but in our view it is not very likely to materialize.
Growth will not go down so fast
We do not estimate that the cessation of Fed purchases and an increase in interest rates, as embodied, will lead to a decline in growth:
Interruptions in quantitative easing did not hurt the growth of the American economy in the decade before the plague. Since 2010 in the QE periods the average annual growth has been about 1.9%. In periods when the Fed did not do QE, the average growth was 2.3%.
We pointed out in next year’s forecast that we published a week ago a series of reasons that make the current expansion in the economy strong and unique in its characteristics. Growth is not just based on cheap interest rates. Cessation of purchases and an increase in interest rates of 1.5% -2.0% are not expected to significantly hurt the progress of the economy.
The profitability of companies in the American business sector is at record levels of the last fifty years (Figure 25).
Although the companies are leveraged and exposed to changes in interest rates, they hold a very high amount of liquid assets. The ratio of total debt to liquid assets has fallen to one of the historically lowest levels (Chart 26). A combination of strong profitability and a high level of liquid assets is expected to improve the business sector’s resilience to rising interest rates.
U.S. household leverage is one of the lowest in history (see 2022 forecast).
While the government sector is highly leveraged, the Fed’s withdrawal does not appear to be causing (at least for now) an increase in its funding costs.
The market still thinks that inflation is transitory
In our view, investors do not adequately assess the risk of inflation. To illustrate this, we examined all the episodes in which inflation has risen above 4% since the 1950s in the main Western countries – Austria, Australia, England, USA, Belgium, Germany, Denmark, France, Canada, Sweden and Switzerland. The following conclusions emerge. :
In cases where inflation rose above 4%, central banks were required to raise interest rates by an average of 4% in order to curb it.
In these cases the peak interest rate reached 7.5% (median) and was never lower than 2.5%.
Inflation at very high levels is “sticky”. In very many cases it only went down for a short period of time and rose again, forcing central banks to resume interest rate hikes.
The thinking that inflation is a thing of the past, as it exists today, was also in the mid-1960s. The average inflation in the decade that ended in 1965 in the above countries was about 2.6%, not much higher than the average inflation of 1.5% in the decade that ended with the outbreak of the plague. However, in the decade that began in 1965 the average inflation has already risen 6.5%.
Today, there are special circumstances that increase the risk of a significant rise in interest rates in order to curb a rise in inflation:
The high growth with a very tense labor market in the American economy.
Never before has real interest rates been so low.
The rise in interest rates, which is expected to start only in 5-6 months, has never been delayed so long after the onset of inflation. The experience of the previous decade shows that QE or its cessation does not affect inflation. Only a rise in interest rates or a reduction in fiscal policy really has an effect.
The Bottom Line: The US bond market embodies estimates that do not match the past experience of central banks in dealing with inflation. In our estimation, long-term yields are expected to rise.
The stock is expected to return to a positive trend
The experience of the previous decade shows that the stock market is indeed affected by Fed purchases. The average weekly return achieved by the S&P 500 during QE periods was significantly higher than during periods when the balance sheet was reduced or stable (Chart 27). At the same time, even in the period of the balance reduction in 2018-19 the market still achieved a positive return.
Even when the Fed rate rises, the stock market usually continues to rise. In periods of rising interest rates between 1990-2021, the S&P 500 index rose by an average of 0.6% per month, compared with an increase of about 1.3% in periods when interest rates did not rise or fall, as in Dot.com and the 2008 crisis (Chart 28).
We estimate that inflation could cause the Fed and other central banks to find themselves “behind the curve” and act aggressively. This is the main risk, but so far it is not the main scenario. In the absence of an exacerbation of health risk, the stock market is expected to continue to be in a positive trend.
In periods of high inflation and rising interest rates, assets with high profit multipliers are usually hit. Value stocks, stocks of companies holding real assets (Reit Equity), heavy industry stocks, infrastructure and materials generally achieved excess returns during these periods.
The Bottom LineA: We recommend medium to high exposure to the equity channel.
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