Zvi Stepak: Government bonds carry risk

"Current prices are expensive, very expensive."

In a new review, Meitav DS Holdings Ltd. (TASE:MTDS) chairman Zvi Stepak has broken the longstanding consensus on investment, claiming that government bonds are no longer a sound investment instrument, but carry a major and tangible risk.

How is it possible to deal with this risk? "Learn the rule: when it looks likely that something is about to happen, it is not so important to assess when it will happen. In such circumstances, do not develop too big an appetite. Be satisfied with lower yields over shorter periods, and wait patiently for the opportunities that will come," says Stepak.

"Israel government bonds have always been considered an anchor investment for savers and investors in Israel, both through direct investment in them and through mutual funds, provident funds, and so forth. This has always been considered a very sound component. But the dramatic changes in the global economy and in financial markets in general, and capital flows to markets and the negligible interest rate policy in particular, have upset the applecart and changed the fundamental consensus," says Stepak.

"Today, buyers of Consumer Price Index (CPI) linked Israel government bonds with a redemption of up to five years know for sure that they are going to lose money. Buyers will not get inflation plus 2-3%, as they did for many years, but inflation minus 0.5%, or even inflation minus 1% or more a year. What is certain here? Nothing, except the loss. The loss is certain up to a certain amount that is known in advance."

Stepak adds, "Buyers of CPI-linked bonds of longer than five years will get the inflation, and even more if they invest in long term bonds with a 15-year redemption (less than 1% above inflation), but then they are exposed to the risk of falling bond prices, which is liable to turn out to be very painful.

"'Bubble' is a meaningless word, and the right question is whether current prices are expensive. The answer is very clear. Yes! Prices are expensive, very expensive."

Stepak notes that the current Bank of Israel interest rate is 0.75%, but that the yield on 10-year Israel government bonds is 3.4%. US government bonds are current traded at an annual yield of 2.8%. In other words, the yield gap has greatly narrowed to 0.6%, which is liable to turn out to be "the trigger for a power change in direction."

Stepak explains the reasons that brought Israel government bonds to these levels: first, they have very high liquidity in the system; second, the budget deficit picture, which appeared very grim a year ago, has greatly improved; and third, the interest rate cuts by the Bank of Israel from 1.75% a year ago to 0.7% today, with expectations of another interest rate cut that is already reflected in Makam yields.

"If US government bonds continue to fall, they will drag down Israel government bonds, which will drag down bank bonds, which will drag down the Tel Aviv Stock Exchange's Tel Bond 20, 40, and 60 indices, which will affect bonds that are not listed on the Tel Bond indices," says Stepak. He adds the rider, however, that this scenario will not occur if the pace of the US recovery disappoints, of if there is a severe geopolitical crisis that drives investors to anchor in safe havens, such as US government bonds."

Published by Globes [online], Israel business news - www.globes-online.com - on March 17, 2014

© Copyright of Globes Publisher Itonut (1983) Ltd. 2014

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