After a sharp rise in stock indices in Israel and around the world in March-May, stock markets have been sluggish over the past five weeks. On the face of it, that's surprising, since several economic indicators published recently have shown stability, and even a rise in economic activity. What are the main economic factors that will affect developments on the markets in the coming months? Here is an economic road map, with four main parts.
Much lower economic growth than before the crisis. Even if the recovery of the real economy continued aboard and in Israel, growth rates and corporate profitability will look pallid compared with what we had in the 2003-2007 period. A prominent example of that is private consumption in the US (which represents 70% of GDP there). A substantial fall in the leverage of the typical US consumer will lead to a consumption level lower than in the past.
Expectations of a rise in interest rates and yields because of the sharp rise in the public debt:GDP ratio. The rescues of banks and other financial corporations, and expansion of government spending in order to encourage activity, together with a fall in tax receipts because of the economic slowdown, will lead to large government deficits, and substantial rises in the public debt:GDP ratio. Over the next few months, these developments are liable to lead to a rise in bond yields, in inflation expectations, and in central bank interest rates.
A gradual exit by governments and central banks from the capital and foreign exchange markets. Forms of intervention that were justified at the beginning of the crisis now seem unnecessary. The exit of central banks from trading in long-term bonds is liable to be accompanied by a rise in yields within weeks. In Israel, shekel exchange rates will also be affected by the Bank of Israel's exit strategy, when it is implemented.
A rise in the economic power of emerging markets at the expense of the US and the West. As a result of this, the currencies of these markets will strengthen against the US dollar and the euro.
Conclusions: Convergence on anemic growth rates, with the risk of higher yields and central bank interest rates, is liable to limit the upside on stock markets. At the same time, the expectation of a rise in government bond yields raises the relative attractiveness of short-term bonds. Finally, because of the high volatility in the dollar and euro, interest is rising in the currencies of emerging markets.
The writer is chief economist at Bank Hapoalim.
Published by Globes [online], Israel business news - www.globes.co.il - on June 17, 2009
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