בצל המחאה: כשיש תחרות - גם הרשתות הגדולות מורידות מחירים
U.S. investors know they can expect little. Over here, all bets are off
With 2002 merely a memory, it's time to take a look at 2003. What can we expect in Israel's bonds market?
Let's start by a moment of retrospection. Last year was a horrible one, by any parameter you choose, but bond yields soared nonetheless. Why?
America has been in recession for two years. The result was a great rally by bonds, because of the aggressive fund rate cuts. Bond holders reveled, to a degree, as stocks slumped. Some people even started calling the American bond market a bubble and worry about a violent correction as share prices recover. The average growth forecast for the U.S. in 2003 is 3.2%.
But note - the difficulty in forecasting, coupled with the cautious optimism about America's economic performance in the year to come, could allow the bubble to empty out slowly.
Anyway, with bonds compensating for the loss of wealth by your average American, in parallel with the government returning tax to citizens and lowering interest rates, households started remortgaging their homes in order to finance consumption, which hardly suffered at all, thus bolstering the economy.
The following table shows profits on bonds and stocks from October 2000, which was the peak of the boom, to date, together with GDP growth in Israel and the U.S. Note the behavior of bond prices in both countries.
| Date | Estimated profit for bond-holders (5-7 year range) | Stock index change* | GDP growth that year | |
| U.S. | 10.10.2000 | 4.6% | ||
| 10.10.2001 | 14.5% | -21.5% | 0% | |
| 10.10.2002 | 11.2% | -25.5% | 2.6% | |
| 31.12.2002 | -1.5% | 11.2% | ||
| Israel | 10.10.2000 | 7.4% | ||
| 10.10.2001 | 14% | -32% | -0.9% | |
| 10.10.2002 | -13% | -10% | -1% | |
| 31.12.2002 | 6% | 3% | ||
* In Israel: Maof-25 index. In U.S.: S&P-500 index.
The table shows that when the U.S. has a bad year, as 2001 was, and 2002 too ¿ despite the hefty growth (still considered a recession in the U.S.), stocks take a beating, but bonds compensate, to a degree.
The same was true in Israel of 2001. The economy swung down, but the same could not be said of 2002, when most of the nightmares came true.
The investing public suffered losses in almost every channel ¿ stocks, bonds, the buying power of the shekel, job security, personal security, and so forth. If in America the capital market is helping economy recovery, in Israel there were no checks and balances to offset the negative trends.
To define the problems more tightly: bond prices in Israel moved together with stocks, despite the sorry condition of the real market, in exact contradiction to developments in the U.S.
So what will happen in 2003?
It's a big gamble, because for the economy and markets to move in the same direction enhances the risk factor of the gamble. In other words, it broadens the width of the probability bell curve ¿ assuming that over here, anything could happen.
The bottom line of the table above describes the behavior of the markets from October 2002 to the end of the year. it shows that in the U.S., investors could derive the direction of the markets from economic performance, hence stocks rose while bond prices dropped.
Here, as share prices rose, so did bond prices, mainly because of a slight fall in the second group of risk factors, including risks that are not purely economic in nature.
Mission nearly impossible
If we could only explain the correlation between stocks, bonds, and the real economy in Israel, we might be able to predict what will happen this year. Americans do not expect extraordinary profits from their bond market in 2003. But over here, attaining such understanding is a mission nearly impossible.
That is mainly because Israel's bond market strongly incorporates risks other than interest rate risks. The Israeli economy is highly exposed to real security risks, some of which have materialized and some of which apparently will, soon enough.
Moreover, Israel's economy is highly exposed to the global marketplace, through imports (goods and fuels), and through exports (which have contributed more and more to economic growth in recent years).
Mix in the culture of government, mainly the issue of accountability by our leaders regarding the performance of their institutions ¿ and we see that the Israeli marketplace is very exposed to damage and negative processes, that could severely undermine the shekel and trigger great disarray.
Under these circumstances, interest policy is relatively important in Israel, compared with the West. It must balance between two main interests: economic performance, versus all the other risks, including existential ones.
The materialization of risk in 2002 led the Bank of Israel to significantly raise interest rates in order to stabilize the shekel and, in fact, the entire market. The public essentially demanded the rate hike, as in the past it has clamored for rate cuts. If we keep in mind that the current high rates were installed in order to firm up the market, we can assess the effect of rate cuts this year.
Cloudiness on the interest horizon
During 2003, the central bank will still have to balance these interests, using interest rates. It is not clear which interest will prevail.
Investors assume interest rates will drop, because of the economic situation: negative growth of 6.5% per capita over the last two years, private spending slumped - for the first time in 22 years - by 2.6%, investments shrank to 20% of GDP, unemployment is climbing.
But Israel is also highly apprehensive about the effects an American attack on Iraq will have on the economy, and on security in general. The effect of an attack on the shekel-dollar rate is not entirely clear, nor is it clear how the Bank of Israel will manage interest rate policy at that time.
The (almost) only interest guiding American interest rate policy is the economic situation. It is clear that bond-holders have little to expect this year. In Israel, investors cannot know what to expect, from interest rate policy or from bonds.
That said, yields on the bond market signal that investors retain some faith in bonds, and in their ability to generate yields based on interest rate policy in 2003.
In conclusion, let us note that Bank of Israel models from 2002 signaled that interest rates should be hiked up by several percent in order to check the potential for price rises. We all sniggered and mocked the models, and the central bank governor went ahead and continued to lower interest rates.
Today, the central bank's models show that it can continue lowering interest rates, based on the sad condition of the economy and various macroeconomic parameters.