Taking Stock / Time to Get Out

Unfortunately, this year we have been forced to interrupt a fairly long tradition and refrain from providing our ridiculous forecasts for the coming year.

Not that we didn't want to, not that we didn't try. But the more we delved into the issue, the more we understood that we cannot provide any genuine service to our readers.

The massive government intervention in the financial markets and economies - the trillions of dollars injected, the acquisition of toxic assets and the nationalizations - have made forecasting even more superfluous than usual.

After three years when our forecasts were more or less on target, the time has come to pay up. Last year we gave our unfortunate readers the following forecasts, among others: a global recession (we were right), a particularly serious crisis in Great Britain (we were right), a recession in Israel (it was much more moderate than we had predicted), a historic opportunity to acquire corporate shares and bonds (we were right), an additional downturn in the stock market (we were wrong, the downturn turned into an unprecedented upswing after mid-March), a crisis in China (we were wrong, China recovered with astonishing speed), a wave of debt rescheduling in the local bond market (we were right) and a failure by institutions to protect investors' money (we were partially right).

The year 2010 is beginning with global optimism about renewed growth, after the major gains in the stock markets. In most parts of the world, people believe the corporate sector is emerging from the crisis, that the increase in unemployment will be stemmed, and that low interest rates will continue pushing investors to take risks.

On the other hand are the balance sheets of governments burdened with huge debts; toxic mortgage-backed bonds that are still stuck on the banks' balances; American consumers - it is hard to say when they will return to consumption, and whether we can even hope that they will return to their former levels; the real estate bubble in China; and the real estate bust in the United States. It is therefore clear why there is little appetite for forecasting - all we can promise our readers is that there will be surprises, and big ones.

And in general, why forecast if we can celebrate the capital markets' amazing year? Yes, if you haven't gotten it yet, 2009 was one of the best years ever for the Israeli investor.

Here are the basic numbers: The Tel Aviv-100 rose 84% in 2009, the index of index-linked corporate bonds rose 33%, the index of index-linked government bonds rose 10% and the index of shekel bonds rose 2.4%. The provident funds and executive insurance had real returns of 20% to 30%, largely erasing the losses of 2008 - the worst financial year ever.

But that is only part of the story. As we know, most of the Israeli public does not participate in the short-term stock market game. The extent of public investments in risky trust funds is only 1% to 3% of the public's portfolio.

Most of the public's involvement in risky assets - corporate stocks and bonds - is carried out via its holdings in provident funds, pension funds and executive insurance funds. And here the news is good.

In spite of the scare tactics at the end of 2008, at the height of the crisis (flee from the provident funds, redeem the pension funds, Benjamin Netanyahu has pushed you into the stock market, the era of stocks is over, et al) - most of the public decided at the time not to decide.

For most investors, not making decisions means a dual decision: It's a decision to leave the money invested in risky assets; and in most cases involving salaried workers, it's a decision to increase the investment on a monthly basis - by means of deductions from their monthly salary.

The financial significance is simple: Most salaried workers in Israel, who every month put aside 10 percent to 20 percent of their salary for pension funds, provident funds and executive insurance, increased their exposure to risky stock market assets at the end of 2008 and the beginning of 2009 - at end-of-season prices. They bought merchandise cheap.

In the graph on the left, you can see the public's portfolio in the past decade. A year after the greatest financial crisis of all times, the public's portfolio is at an unprecedented height - more than NIS 2.2 trillion.

The steep increase reflects the return of the stock market to a level close to its record high. The Tel Aviv-100 Index is only 8 percent lower than its all-time record.

But more than that, it reflects increases in the bond market as a result of the lower interest rates.

All that is well and good. But this is also the moment when every investor, every saver, must recall the fear that seized him a year ago, when his investment portfolios were down 20 percent to 30 percent within a few months - and he had to decide whether to be exposed to these types of risks and losses.

The investment portfolios of most of the provident funds, executive insurance and pension funds are exposed now more than ever to volatility and crises. The upswing of 2009 did not change this situation. There could be a repeat of 2008.

Anyone who is incapable and unwilling to face this volatility should not wait for the next crash. He should act now.

In the next crash, he will not be able to say that he didn't understand, didn't know, relied on the bank official, on the government or on the prime minister. Nor can he say that the government transferred the provident funds from the banks to external financial institutions. That was not relevant, nor will it be. The only determining factor is the component of risky assets in portfolios - and it is now quite large, once again.

Every Israeli citizen today has a good understanding of the risk in the financial markets, and anyone who loses a substantial portion of his money in the next crash will have to himself to blame first.

As we know, most investors tend to see their profits - whether only a few percentage points or tens of percentage points - as something self-understood. Something that requires no explanation. Something natural and obvious. On the other hand, losses seem like a terrible mishap at best, or a catastrophe at worst. But the financial truth is simple: If the provident funds can increase by 20 percent or 40 percent in an amazing year like 2009 - that means they can also decline by that much. And anyone who is unwilling to be subject to the volatility should decrease his exposure now.

The price of reducing exposure is, of course, the returns. Investors seeking low-risk investments will discover that interest rates are nearly zero. That is neither a mistake nor a coincidence - it is a deliberate policy by most governments and major banks in order to staunch the bleeding from the financial crisis. So far it has worked well - but nobody knows the precise nature of the central banks' and governments' "exit strategy" - and especially how the markets will look when the massive intervention ends.

Anyone who believes that the governments will leave the markets easily, and that the economies and the stock markets will continue to flourish on their own, without the intervention of the authorities - expects more gains in the capital markets in the coming years, and sees 2008 as a "mishap" that was corrected by economic leaders.

But not everyone is convinced by this scenario, and over the next few months, anyone who fears that the next crisis is around the corner will take advantage of the high prices in order to reduce exposure, accumulate cash and wait for the moment when money is expensive once again.