The Pangs of Low Interest Rates

Are the market gains the start of another bubble, fueled by low interest rates in Israel and everywhere else?

I missed the rally, whimpered a seasoned market animal last week, a person who doesn't invest a shekel without studying and analyzing each potential move. In depth.

"When I try to understand why the market got away from me, I think I didn't realize how panicked people had become about the fact that their money wasn't accruing returns. It was simply killing them."

He got that right. In October and November, the question on everybody's mind was whether to stay in the market or flee. From December to March, investors simply sat back and waited to see what would happen. But from April, the pressure on the people to do something with their money began to mount - anything, except let it sit there in the bank "doing nothing."

That antsiness takes several forms. In the last couple of weeks, more people have contacted us than in the preceding year, asking for advice - "The banks aren't paying any interest at all. What should I do with my money?"

Some have started to eye the real estate market, with the idea of buying an apartment as an investment (rather than as a home). Within months people morphed from terrified savers into potential property speculators eagerly learning the market and looking for an asset to buy and lease out. Real estate brokers in the greater Tel Aviv area report a huge surge in exploratory phone calls.

The logic is simple. They have nothing better to do with their money. Mortgages are cheap and buying an apartment and renting it out could bring them safe returns of a few percent a year.

At the level of sheer demand, the market of apartments for investment is frothing anew. But the lively interest hasn't translated into sales figures just yet. Buying an apartment isn't a snap deal. It takes months. And also, the sellers have noticed the awakening demand and have started to jack up prices, which isn't good for the returns that the hungry buyers want to achieve.

Reluctantly, with keen memories of their burns from the crash of 2008, a lot of investors are sidling back into the markets, including stocks. But is this influx of investments healthy? Is the money entering the stock market smart money? Are these people getting in for the long run?

Or is it foolish money, driven mainly by the abhorrence of zero interest on bank deposits, that will exit the market the moment the next downturn hits (and it will), or the moment more conservative alternatives arrive?

In other words: Are the market gains the start of another bubble, fueled by low interest rates in Israel and everywhere else?

The answer depends on the broader economy outside the financial system. In two words - corporate profits. The first-quarter results weren't as bad as had been widely feared and helped fuel the gains in asset prices this year. But further gains, the kind that would validate a decision to get into the market today, depend on further improvement in corporate profits in the second and third quarters, and in the following ones as well.

Maybe we're all in for a surprise. But no such thing is apparent in indications from businesses. Companies that ship products to and from Israel, for example, aren't reporting an upswing in operations.

They're reporting stability, a return to routine, adjustment of costs, preparations for better days, but not a powerful rebound in business. There are exceptions, but the rule seems to include local goods-and-services providers, too.

Perhaps the message will come from abroad, maybe from the United States, which was first to stumble into crisis, and which may be first to exit it.

Well, it's true that sentiment and the level of economic security are improving there. But the data continue to signal that America remains in recession. Housing prices, the state of commercial real estate and jobs data are all still in retreat. The only thing you can say is that the pace of the deterioration has slowed a great deal.

A last factor that could drive another increase in the markets, even in a weak economic environment, is a situation in which share prices are really low. That was the case in November and December. After the gains this year, it isn't the case anymore.

In the United States, profit and equity multiples have returned to their levels of boom years. That is certainly not in and of itself grounds for a crash, but most analysts agree that prices aren't that alluring anymore. That's true here in Israel, too.

Maybe the stock market simply returned to normality, the kind where investing in stocks over the long run returned 10% a year in the past (in the United States).

Maybe, but nothing could be less certain, especially if the investors who're coming in really are weak and will flee when bonds recover.

Economists analyzing the influence of the tremendous government injections into the economy - and the consequent need of these governments to raise vast amounts on bond markets - think this is exactly what will happen.

In other words, the low interest rates are driving people crazy. They're pushing people into avenues they'd rather not visit. They're inflating prices. But interest rates won't stay low forever.