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The 2014 Trap For Israel's Solid Investors

|Includes:CEL, iShares MSCI Israel Capped ETF (EIS), GOV, GOVT, GOVY, ICL, IPHXF, IRLCF, ISDAF

The most astonishing thing about the pricey Israeli government bonds is that the majority of investors just don't pay attention to it at all. From the beginning of the year ILGOV 03/23 is up 3.97%, and this bond is not alone, the government bond index is up 2.11%. Is this normal? I definitely think there is no reason for this amazing run in 2014 until now.

So why are their prices so high you might ask. The answer is clear - the ONLY reason is because investors have no alternative. In the past few years, Israelis were used to the fact that the best alternative for an investment was real-estate, and they were correct. Real estate prices rose approximately 80% since 2008, without taking the yield that investors got from rent into consideration. But there is a different atmosphere nowadays. Because the real estate prices are so high, a clever investor would get only a 3.5% yield in Tel Aviv area and around 4-5% in Southern and Northern Israel. But the big change is that most people believe that the real-estate prices are not going to rise anymore, or at least not at the rapid pace they increased recently.

So where do they go? you guessed it correct, to TASE - Tel Aviv Stock Market. Volume at the last half year rose 12.3% and mutual funds are recruiting around a billion NIS per week - an all-time high. Israeli "Mom & Pop" investors are no different than their colleagues around the globe - they will go "long" at the worst time and sell when they shouldn't. Most of them just want "3-5% yield a year with no risk", they just don't understand that that era is long gone. Investment consultants are doing their job and they are sending them to buy government bonds. The investor's consultants memorize by heart all the cliches like "the spread between the government bonds to the corporate bonds is not sufficient" and they are correct. (Currently the spread between the corporate bonds to the government does not present the risk, surprisingly the case gets worse with the bonds which get high ranking from "S&P- Maalot" and "Midrog"). But why don't they do the same comparison between government bonds is a good question.

The current yield on the 03/23 (Which ends on March 2023) government bond stands only on 3.21%. I ask myself, can it be? Is Israel the new economic super-power and I just haven't noticed? Let's check the 10 year U.S government bond - currently the yield is 2.75%. We can see that the spread between the two is definitely very low and does not include many aspects. Israel, with all due respect, is still in the Middle East with many geo-political problems, slowing growth and problems with its foreign exchange rates. If that's not enough, the average spread between an Israeli bond and its parallel American bond was around 1% at least in the last several years. This all-time low spread between the two is not only for bonds that have many years to maturity; but also the shorter ones are in their all-time lows.

But the problem is even bigger than the small spread; In my opinion the only direction for government bonds in the Western countries is higher yields. Janet Yellen, the FED chairwoman said on the last FOMC convention that the QE3 is expected to be over around the end of 2014 and there is a chance that the interest rate will rise approximately six months later. At the moment the QE3 will come to an end the yield on the American Government 10 year bonds is expected to rise above 3%. I prefer not to think what would happen to Israeli investors in the Israeli pricey government bonds at the moment the yield on the American will rise. The longer the bond - the bigger the hit.

So not only the Israeli government bonds are very expensive compared to the American ones, the American ones are not attractive at all by themselves. This is the trap of 2014; extremely solid investors are trying "just to beat the inflation" and because so many of them are doing the same, they are getting the wrong price. If there is no extreme event, the Israeli government bonds won't collapse but in my opinion the current price is way too high, and investors should be aware of the risk. The current run in the government Israeli bonds can not continue in its rapid pace. Since the expected inflation rate for the near future is low, I think that the most solid of investors should consider to do some asset allocation and move some of their investments to cash. If the investors are willing to take on some risk they should think about the main stock indexes like TA-25 and TA-75 rather than investing in corporate bonds which are pricey as well.

(Disclaimer: All of the content ןn this blog is my personal opinion. The blog does not constitute investment advice and can not be held against me or my employer.)

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