Israeli Savings Under Threat as Stock Market Exposure Soars

Recent declines in Wall Street, with the S&P 500 down 2% and the Nasdaq down 4% last week, alongside bond yields exceeding 5%, are raising concerns about the sustainability of stock market gains. Factors contributing to this potential "perfect storm" include worries about AI's impact, global debt levels, inflation, interest rates, and geopolitical tensions. This situation brings back a critical question largely absent for a decade: does the higher potential return from stocks justify their increased risk, and are they still the best default savings vehicle?

For Israelis, this question is particularly relevant as their exposure to the stock market in savings and pension funds has reached unprecedented levels. Data from the Capital Market Authority shows that stock allocation in general tracks of study funds rose from about 24% in 2010 to over 52% today. Similarly, in pension tracks for those aged 50 and under, stock exposure jumped from 42% in 2016 to 58% currently. This dramatic increase, more than doubling over 15 years, occurred alongside a decrease in bond holdings, which are considered lower risk but also lower return. This mirrors a trend in the U.S., where the classic portfolio is 60% stocks and 40% bonds.

This shift towards higher stock allocation has been highly profitable since 2008, with Wall Street avoiding prolonged major crises. While the 2008 crash saw stocks lose 50% of their value, the COVID-19 downturn was around 30%, and 2022 saw smaller declines. Savers have enjoyed significantly higher returns compared to bond investments, with estimated excess returns amounting to hundreds of percent over two decades.

Despite the clear incentive to shift towards bonds as yields on major Western government debt reach historic highs, institutional investors are not reducing their stock exposure. A senior market source suggests this is due to competition for yields, stating, "They have to continue like this." This source also warns that many savers are unaware of the dramatic change in their pension fund's risk profile, noting that the public discourse has focused on returns rather than the level of risk taken.

However, Eyal Shina, Senior Vice President of Investments at Pasternak Shehem, advises against overreacting to recent drops, viewing the increased stock exposure as a sound strategy for long-term investors. He argues that with investment horizons of 10-20 years, short-term fluctuations are negligible, and historically, stock markets have delivered positive returns over time, even amidst rising interest rates. He also points out the difficulty in timing market exits and re-entries, citing the COVID-19 pandemic as an example where staying invested was the correct long-term strategy.

Amir Kahanovitz, Chief Economist at Profit Group, views the rising bond yields not necessarily as a warning sign for stocks. He explains that rising yields can stem from various factors: increased inflation expectations, higher risk premiums, or increased demand for investment capital. Kahanovitz suggests that if yields rise due to companies seeking capital for expansion and investment opportunities, it can be a positive indicator for the stock market, signaling growth. He dismisses concerns about U.S. debt as background noise, as investors are pricing in the ability to service it. Therefore, he concludes, rising bond yields do not automatically necessitate reducing stock allocation, as the market continuously prices in interest rates.