highlights
All the factors are expected to lead to a moderation in the rise in housing prices in Israel in the coming year.
The lag of inflation in Israel after the other countries is concentrated on clothing and footwear, transport, food and education.
In December, there was a slowdown in global growth, especially in the services sector.
U.S. economic data continues to be strong.
Markets do not believe that US inflation will persist.
The Fed is probably more “hawkish” in its plans than it presents itself.
If US inflation is real here, as we estimate, monetary policy will have to be more restrained compared to Fed forecasts.
It is difficult to draw clear conclusions from the performance of the entire U.S. stock market or the various sectors in periods of first-time interest rate hikes that have taken place in the past.
Israel.
The rise in apartment prices is expected to moderate
In our opinion, an increase in housing prices in Israel is expected to moderate in the coming year under the influence of the following factors:
An increase in purchase tax is expected to bring down investor shopping, as happened after a similar move in 2015.
The government is significantly speeding up land marketing. The number of building permits in April-September increased by 30% compared to the corresponding period in 2019 (Figure 1).
Apartment prices have risen by 10.3% in the past year. Since 2010, the rate of increase in housing prices has stalled at levels of about 10% (Figure 2).
The ratio between the price index of owned dwellings and the rental price index (the housing item in the price index) rose to a peak (Figure 3), which should lower the attractiveness of investment in dwellings on the one hand and increase demand for rent on the other.
Purchases of apartments by young couples outside the “price per occupant” were the lowest in October since May. This fact may indicate a decline in demand from primary buyers, possibly due to rising prices.
The amount of new apartments for sale has started to rise in recent months. Also, there is probably a large inventory of second-hand apartments for sale. According to the Ministry of Finance, the number of “shelf months” of apartments sold by housing developers was 34 months in October, a long period of nine months compared to October last year. Housing developers are in no hurry to sell apartments due to the extension of tax exemption During the corona period and because prices continue to rise, however, these apartments may “spill out” to the market as soon as the order expires and / or the rise in apartment prices stops.
The average repayment on the new mortgage has risen by almost 25% in two years, despite the decline in the average mortgage interest rate (Chart 4). This situation may alienate many apartment buyers.
The cost of buying apartments is rising beyond what is reflected in an increase in the price index of apartments. Rising inflation raises repayment on indexed mortgages, which make up about a quarter of new mortgages. In addition, the index of construction inputs to which the prices of new dwellings are linked has risen by 5.7% in the past year, the highest rate since 2006.
In which sections is inflation in Israel lagging behind the world and in which leader?
The consumer price index in Israel rose less than forecast in November and overall its rate of increase remained low compared with most developed countries (Figure 5).
The clothing and footwear segment has decreased in the past year by 8.4% in Israel, in contrast to the increases of the United States, the United Kingdom and Germany (Figure 8).
The transportation item was also significantly lower in Israel due to a smaller effect of the increase in fuel prices and due to the sharp reduction in the expense of travel abroad.
The increase in the price of food in Israel was lower than in the other countries, mainly due to the reduction in the price of vegetables and fruits.
In addition, the education section increased less in Israel than in the other countries.
In the other main sections – housing, furniture and equipment, culture and entertainment and health, Israel was no different or even higher than the other countries. Furniture and equipment prices rose in Israel more than in other countries despite the strengthening of the shekel (Figure 7).
The producer price index in Israel rose at a higher rate than in most countries, despite the strength of the shekel (Figure 6). Strong growth and rapid improvement in the labor market are also expected to contribute to rising prices.
On the other hand, the reform initiated by the government to lower import barriers in various areas may indeed have the effect of lowering prices, only it is difficult to estimate how much.
world.
The slowdown in growth in December, mainly in the services sector in Europe
Preliminary purchasing managers’ indices for December indicate a slowdown in growth in the Western world. Manufacturing activity continued to expand at a relatively steady pace in the United States, Europe, and Japan (Figure 9). In contrast, procurement managers in the services sector declined in Europe and Japan due to morbidity (Figure 10). The number of morbidity waves in Europe is the largest since the onset of the plague.
The company conducting the survey (IHS Markit) reports that there has been some relief in lengthening delivery times and plant costs (Figure 11), but they are still at very high levels. It should be noted that recently sea freight prices have risen again, with cargo flying prices, especially from Asia, soaring to higher levels than those in the spring of 2020 (Figure 12).
The American economy continues to expand and prices continue to rise
U.S. economic data continue to point to a rapid expansion in activity. The manufacturing production index rose at a relatively high rate in October and November, with manufacturing resource utilization returning to pre-crisis levels (Chart 13).
Americans continue to purchase a lot of products, as evidenced by the rapid growth in retail sales (Figure 14). One only has to take into account that the figure is skewed upwards due to rising prices.
Inflation figures continued to surprise upwards. Both the producer price index and the U.S. import and export price index were higher than forecast (Figure 15). The proportion of small businesses that reported price increases was the highest since the 1970s (Figure 16).
What do the markets think about the Fed’s steps, what does the FED itself think and what is expected to happen in practice?
With regard to the Fed’s decision from last week, responses should be separated on three levels:
What does the market think?
What does the Fed think compared to what it says?
And what is happening in reality?
The financial markets express a lack of confidence in the ability of the central bank to implement its plans. The market still thinks that inflation is a temporary phenomenon and will disappear with or without a rise in interest rates. Since the publication of the surprising price index for October, which caused the Fed to stop using the word “transitory” and change its policy, last week market changes were minor or even the opposite of expected:
The 5-year yield rose by only 0.1%.
The forecast for interest rates at the end of 2023 according to the contracts has risen from about 1.4% to only about 1.5%.
5-year inflation expectations fell from 3.0% to 2.7%.
The Fed has apparently made a significant turnaround and put inflation as the target it is about to fight. The actual change was not dramatic. It increased the expected number of interest rate hikes next year from one to three, did not change the number of interest rate hikes in 2023 and lowered one interest rate hike in 2024 (Chart 17). The long-term interest rate remained unchanged at 2.5%. This does not seem like a big enough change in the face of the jump in inflation.
According to his forecast, the planned rise in interest rates will be enough for an increase in inflation to slow down, although only in 2024 will the interest rate rise to the level of inflation. This is when the Fed’s updated inflation forecasts are the lowest of any survey or other forecast of consumers, businesses, forecasters and even of the inflation inherent in the bond market which as stated does not believe so much in inflation (Chart 18).
At the same time, there is reason to fear that in practice the Fed is more “hawkish” than it predicts.
First, almost all governors in the Monetary Committee think that the risk to their inflation forecast is upward (Figure 19). In other words, they think inflation may be higher than the forecast they gave.
Second, the governors predicted a decline in the unemployment rate to a level of 3.5%, which was on the eve of the crisis, for next year compared to 2023 in the previous forecast. Despite the introduction, this forecast assumes a significant slowdown in the rate of decline in the unemployment rate compared to the last six months (Figure 20). Given the fact that according to business surveys, wage increases are one of the two main factors leading to rising inflation, this forecast by the Fed assumes that inflationary pressures from the labor market are not expected to weaken.
In conclusion, it seems that the forecasts for the increase in interest rates presented by the members of the Monetary Committee may be biased downwards compared to what they expect to happen in practice. They may prefer to reveal their true predictions gradually so as not to cause a shock in the markets.
In reality, if US inflation is real, monetary policy needs a really restraining order to curb it. (Figure 21). As long as there is no increase in bond yields, corporate bond spreads and / or declines in the stock market, inflation is not really halted.
The Bottom Line: In our estimation, if nothing out of the ordinary happens, the Fed will raise interest rates immediately upon completion of the acquisitions already at its March meeting and will update upwards the future route. However, even under the current route, it is difficult to expect long-term bond yields to remain at 1.4% in a year, with the interest rate on cash standing at 0.9%.
The ECB still insists on not changing messages
The ECB continues to follow the path the Fed has followed until recently. Meanwhile, inflation in Europe is rising rapidly. The rate of increase in the prices of non-energy products is the highest since the establishment of the Eurozone. Services prices in Europe have also been rising at the highest rate since 2008 (Figure 22). In our estimation, with a fairly high chance the ECB will soon have to change the message to a more restrained one and eventually do what the Bank of England did, which surprisingly raised interest rates at its meeting last week.
It is difficult to draw clear conclusions from the past about stock market performance in periods of first-time rise in interest rates
The stock market is becoming very volatile, but the S&P 500 is only about 1.9% from its peak. In contrast, the Nasdaq is 5.5% far and the Russell 2000 is 11% high. Despite the relatively small decline of the S&P 500, the changes within the sectors over the past month have been significant and even revolutionary.
In the last month, the infrastructure, current consumption and health services sector have led. These were exactly the sectors that showed a lackluster return relative to the S&P 500 in the previous three months. In contrast, the sectors that led in the three months preceding the last month – energy, cyclical consumption and technology – showed poor performance in the last month (Figure 23).
An examination of the relative performance of the various sectors before and after the first interest rate hike by the Fed since 1994, the results of which are shown in the table below, does not reflect a clear picture. Infrastructure was weaker.After the interest rate rose, the communications sector always showed an excess return and the health sector a lacking return.
Since the rise in interest rates in 1983, the performance of the S&P 500 has been mostly positive in the six months before the first rise in interest rates, except in 2015. The dangerous period was immediately after the first rise in interest rates during which the stock market generally declined, but corrected in the following months (Chart 25).
According to the weekly survey of private investors in the US, they are very pessimistic. Historical experience shows that when the rate of “bullish” investors was as low as today, the market rose in the three months after the survey in 90% of cases and achieved an average return of 5.8%. ).
The Bottom Line:
We recommend medium-high exposure in the equity channel.
We recommend overweight exposure to the U.S. market and underweight to emerging markets. Investment in Europe market weight.
There is a preference for investing in growth sectors, especially in the stocks of companies operating in the US, particularly in the services sector.
Overweight exposure to the Israeli stock market is recommended.
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