In a review focusing on geopolitical risk in the Israeli securities market, Citigroup Global Markets finds that there is little evidence that recurring conflict has had a negative impact on the Israeli economy. Israel's GDP has grown at 5.5% p.a. since 1960, compared with global GDP growth of 3.5% and population growth of 2.6%. Israeli equities have returned approximately 20% p.a. since 1992.
However, analysts Michael Klahr, Andrew Howell, and David Lubin note that the past is not always a good guide to the future, and neither are current asset prices. "If Iran really is an existential threat to Israel, that is bad news for the Israeli economy and asset prices regardless of strong underlying fundamentals and economic policy," they write. They also observe that if Iran and Israel did go to war, Israeli holdings would be the least of international investors' worries. "US involvement, oil nearer $200 and increased chances of a global recession could all be of greater concern."
There is some discernible impact of conflict on specific sectors. Tourism, for example, accounts for less than 5% of GDP, far lower than Greece, Spain and Portugal, despite good weather, beaches, and no shortage of sites of historical significance. On the spending side as well, defense spending was 17% of total government spending in 2007, far higher than in other OECD countries. "In the absence of military conflict, this is money that could be put to better economic use, in the form of infrastructure, education and other higher ROI (over the long term) investments. Nevertheless, Israel’s overall long-term economic record is undeniably a good one in a global context," the analysts comment.
Even more difficult to discern, according to Citigroup, is the effect, if any, of conflict on Israeli markets. "The TA100 sold off -7% at the start of the Second Lebanon War (July 2006) but had recovered its losses by the time the war ended in late August and closed the year 18% higher than its July low. In September 2000 at the start of the second intifada (Palestinian uprising), the TA100 only sold off 2% in the first week of hostilities but within a month was down -19%. It would not recover its 564 level (on the eve of hostilities) for three years, although the global tech collapse together with poor macro policy were arguably more important drivers of GDP and equity market returns over the period," the analysts write.
Overall, Citigroup's approach to the Israeli market is that it presents a compelling long-term investment thesis but that it calls for caution in the near term. "Long-term GDP growth above 3%, credible macro policy and management, reasonable valuations, and a large and growing local institutional investor base are all supportive of equity market outperformance vs. new developed market peers in the coming years. Near term, we are less optimistic with economic growth rates rolling over, gradually rising policy rates, lack of developed market investor interest and high equity weightings for local institutions all obstacles to short-term performance."
Citigroup's favored stock in domestic Israel is Bezeq The Israeli Telecommunication Co. Ltd. (TASE: BEZQ), where the analysts find good earnings momentum, and where dividends should be more than enough to protect any downside. "A lot of air has come out of the stock over the last three to four months and in our view the market seems to be overly concerned by regulation."
The other company the report mentions is also in the telecommunications sector: Cellcom Israel Ltd. (NYSE:CEL; TASE:CEL)."Analysts have been bringing mobile numbers down following the Ministry of Communications MTR cut announcement, but we don’t see the overall hit from interconnect being as bad as many are expecting; because of the structure of the market the operators have plenty of ammunition to increase prices and also to lower costs," the Citigroup report says.
Citigroup is also impressed with Israeli banks, saying they should be a good investment over the longer term. The report finds Bank Leumi (TASE: LUMI) to be the pick of the sector.
Published by Globes [online], Israel business news - www.globes-online.com - on July 28, 2010
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