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Josh Kaplan & Steven Schoenfeld, BlueStar Global Investors: BlueStar Israel Equity Market Review and Outlook: Q1 Review & Q2 Outlook

Published on Apr 26 2012 // Columnists

April 26, 2012–This new monthly column written by the staff of BlueStar Global Investors, a financial information firm focused on Israeli, Mideast and Mediterranean markets, will provide an overview of trends and developments in Israel’s dynamic economy and capital markets. It will introduce themes, sectors, market trends, and individual companies to curious investors, highlighting the many interactions between Israeli and global markets.

A Positive Trend Reversal

During the first quarter of 2012, Israeli markets reversed last year’s trend of decoupling from U.S. and other developed equity markets. The BlueStar Israel Global Index (BIGI), the broadest and deepest benchmark of Israeli equities, gained 11.72%, while the local Tel Aviv-100 gained 5.12%, and the MSCI Israel Index gained 8.87%.

Israel underperformed U.S. equity markets, with the S&P 500 gaining 12.00% during Q1 2012 YTD; but Israel outperformed MSCI EAFE, a broad gauge of Developed Markets outside the U.S. used by institutional fund managers. MSCI EAFE gained 10.80% during the quarter. Emerging Markets gained 13.20% during the quarter, as measured by the MSCI EM index.

Over the past 10 years, Israeli and U.S. equity markets were positively correlated, with Israeli equities significantly outperforming U.S. equities. It’s possible that 2011 was just an aberration and that Israeli equity markets are poised to cover some of the lost ground during the remainder of 2012. But regardless of Israel’s relative performance, the broad Israeli equity universe – encompassing companies listed in Tel Aviv, the U.S. and elsewhere – provides exposure to ten diverse and globally oriented economic sectors.

Q1 2012 Sector Performance; Winners and Losers

The top performing sector within the BlueStar Index benchmark during the first quarter of 2012 was Information Technology, and the leaders in this sector were Tower Semiconductor ( TSEM:NASDAQ ) and Click Software (CKSW:NASDAQ), which gained 39.63% and 32.33% respectively. The Information Technology sector was the only group of equities to make gains in 2011 and has built on this strength to lead Israeli equities out of 2011’s slump.

The worst performing sector of 2011 was the Banking and Financial Services sector, which made a sharp reversal to start off 2012 positively. The reversal was led by the First International Bank of Israel (FIBI:TASE), Africa-Israel Investments Ltd. (AFIL:TASE), and other large banks, including Bank Hapoalim (POLI:TASE)and Bank Leumi (LUMI:TASE). The underperformers within this sector were large holding and insurance companies. Upcoming debt restructuring in Israel’s corporate debt market and the anticipated regulatory changes that will affect Israel’s large holding companies may present hurdles for companies in this sector. However, lower-than- expected required core tier capital ratios along with the prospective loosening of monetary policy will make it easier to overcome these hurdles.

The worst performers in the first quarter of 2012 were Telecom Service Providers, which collectively lost 1.08%. Stiff price competition and regulatory burdens continue to weigh on these companies’ earnings power and forecasts.

 

Sector

As defined by BlueStar Indexes

Q1 2012

Performance

Full Year 2011 Performance

Information Technology

3.06%

0.30%

Healthcare and Pharmaceuticals

2.07%

-0.25%

Banks and Financial Services

0.82%

-4.22%

Technology

0.71%

-1.05%

Materials

0.58%

-3.46%

Energy and Exploration

0.36%

0.01%

Construction and Real Estate

0.27%

-1.47%

Industrials

0.26%

-1.67%

Consumer Discretionary

0.05%

-0.78%

Consumer Staples

0.02%

-0.47%

Telecom Services

-1.08%

-2.74%

Source: BlueStar Global Investors LLC

Top-Performing Israeli Stocks in Q1 2012

Worst-Performing Israeli Stocks in Q1 2012

First International Bank of Israel

55.59%

Internet Gold-Golden Lines

-37.56%

EZ Chip Semiconductor

52.95%

B. Communications

-37.22%

Africa-Israel Properties

51.36%

Kardan NV

-30.21%

Verifone Systems

46.03%

Audiocodes

-29.74%

Tower Semiconductor

39.63%

 IDB Holding Corp

-27.42%

Koor Industries

39.17%

Mivtach Shamir Holdings

-26.36%

Prolor Biotech

38.17%

Cellcom Israel

-24.01%

Live Person

33.63%

El Al

-22.30%

Click Software Technologies

32.33%

Clal Industries

-22.22%

Taro Pharmaceuticals

29.19%

Clal Biotech

-20.52%

Source: BlueStar Global Investors LLC

First International Bank of Israel (FIBI:TASE) provides banking services to large and mid-sized public businesses, small private businesses, and individuals and households. The company is one of the five largest banking groups in Israel and also has subsidiaries in the UK and Switzerland. FIBI is a market leader in capital markets, foreign exchanges, private banking, corporate finance and global trading. The bank has over 100 billion NIS in assets and boasts a large capital base and solid liquidity ratios. FIBI is a prime example of a stock on which pressure has been relieved by less-stringent-than-expected Basel II core capital ratio requirements set by the bank of Israel.

EZ Chip Semiconductor (EZCH:NASDAQ) provides ethernet processors for networking equipment. Networking equipment suppliers use EZ Chip’s technologies as a single chip solution to form the core of networking equipment. Networking equipment is used in switches and routers, and voice, video, and data integration. EZ Chip Semiconductor is an Israeli company at the forefront of one of the most transformative waves of technological advancements in history: seamless networking and data integration.

Verifone Systems (PAY:NYSE) provides systems and solutions for the secure electronic payments systems which are taking over the way consumers and businesses make transactions across the globe. The company’s products and solutions are used in the hospitality, petroleum, transportation, government, and healthcare vertical markets, and consist of point-of-sale electronic payment devices. The company is also developing solutions for payments via smart phones and credit cards with chip technology—which are the future of electronic payments. Because of its large global footprint, Verifone Systems has flown under the radar as an Israeli company.

Broad Market Trends – Technical Analysis and Market Fundamentals

Technical Analysis
From a technical analysis perspective, Israeli stocks, as measured by the broad-based BlueStar Israel Global Index (BIGI), found support during Q1 2012 around the index level of 200 (see solid red support line on two-year chart below). As indicated by the dotted-black uptrend line on the chart below, the short term outlook for Israeli stocks is promising, especially with the tentative breakout above the 225 index level. The outlook remains bullish as long as support levels from early this year are not breached. The key support levels are the 200/197 two-year support index level and the recent upward trend line (dotted black line) that began earlier in the year. Based on the breakout from the downward trend line with mid-2011 as its origin, the medium term upside objective is 255 (the dotted red line).

(3/31/2010 – 3/31/2012)/Source: BlueStar Global Investors LLC

The longer-term outlook for Israeli equities is decidedly bullish, as illustrated in the BIGI five-year chart below, which spans the entire 2008-2009 global financial crisis. BIGI, like other Israeli indexes, bottomed in late-October 2008 and again in early-March 2009, followed by a powerful rally into spring 2010.

After a short correction, it surged to life-time highs in late 2010 through spring 2011, only to correct deeply again amidst Europe’s financial crisis, Israel’s domestic social protest, and nuclear threats from Iran. It found solid support during late 2011 at the key technical level of 195. This corresponds with an uptrend beginning with the early 2009 bottom (the solid black uptrend line), and the horizontal support zone dating back to autumn 2007 (the solid red line), also at approximately the 195 BIGI level.
In addition to the double bottom at the key support level mentioned above, we also see a breakout of the downtrend line (black dotted line) which began in mid-late 2011 at the 225/230 index level. Initial key resistance is projected to be at 245, as highlighted by the dotted green line. If this resistance is broken, we see the projected upside potential of the index to be at the 300 level by the end of 2012 or by early 2013, though likely with a consolidation at the 2011 high of 275.

From a risk management perspective, there is a clear area for a stop-loss at the 192/195 level zone. The primary risk factor that could create such a downdraft is geopolitical. Monetary tightening and other policy risks are secondary, as the Bank of Israel has taken a loosening stance lately and prospective additional regulatory burdens seem to be built into market prices at this point.

(1/1/2007 – 3/31/2012)/Source: BlueStar Global Investors LLC

Fundamental Analysis

The companies comprising the top one-third, by weight, of the BlueStar Israel Global Index have traded at collective price-to-earnings multiples (based on TTM earnings and prices after the reporting year’s earnings season), beginning with 2008, of 25, 30, 27, 24, and 20. The weighted moving average of trading multiples for these companies is 24.1. According to historical standards, global Israeli equities are trading at a discount to historical multiples. The year 2011 saw mostly a positive trend, but equity prices were affected by global and geopolitical uncertainties, which were a major factor over the past five-year period. Therefore, it seems that the broad 2011 sell-off in Israeli equities may have been overdone.

Trends and Outlook
In 2011, GDP grew by 4.7%, though annualized quarterly growth declined throughout each quarter of the year. A shift in Israel’s net-exports moderated GDP growth in 2011 as the shekel strengthened and euro-zone economic contraction weighed on Israel’s foreign trade. At the end of 2011, the Bank of Israel forecasted 2012 GDP growth to be under 3%. Also towards the end of the year, the Bank began reversing the tightening monetary policy that it started in the middle of the first quarter of 2011.

By the end of the first quarter of 2012, the Bank of Israel raised its 2012 GDP growth forecast to 3.1% and its 2013 GDP growth forecast to 3.5%–based primarily on positive economic indicators for Israel’s net exports. The shekel weakening which began in late 2011 had also begun to have moderating effects on Israelis’ demand for imported goods. The bank of Israel expects to lower its benchmark interest rate to 2.5% from the 2.75% rate with which it ended 2011; and it predicts unemployment will be 5.8% in 2012 and 5.7% in 2013.

What to Watch For:

1- Housing Prices  One of the major financial stories of 2010 and 2011, and so far in 2012, has been the cost of living in Israel–namely housing prices. In 2010, one of the best investments in Israeli equities was in the building and construction sector, as demand outpaced the supply of available housing in Israel. Regulatory changes in mortgage origination and tightening monetary policy in 2011 helped to ease the rise in housing prices so much that many began to predict a hard landing to the supposed bubble in Israel’s real estate market. Developments in this industry could play a significant role in the stability of Israel’s economy going forward.

2- Energy Sector  Continued attacks on gas pipelines in the Sinai and the continual rise of electricity rates (estimated at 8.9% in April 2012) have underscored the need for Israel to develop natural gas fields. The natural gas industry has the potential to transform Israel’s macro-economic and geopolitical situations. A domestic and export natural gas program will help ease rising electricity rates and provide a major source of GDP growth and tax revenue. Noble Energy is getting ready to lay underground pipe work from the Block 12 natural gas field to Cyprus. The pipeline would bring gas to an LNG (liquefied natural gas) terminal off Cyprus’ southern coast and would allow for the export of LNG to Europe and Asia.

3- Spillover impact from European markets and economies  While Israel’s trade flows are quite balanced between North America, Asia, Emerging Markets and Europe, the latter remains the largest single market for many Israeli exports. Continued economic weakness in Europe could dampen Israel’s output, and sharp drops in European markets could also have an impact on Israel’s stock market. On the other hand, signs of stability or a turnaround in the European situation could lead to further positive support for Israeli stocks.

4- Geopolitical Situation  The internal situation in Syria is getting worse and the American and Israeli stance on Iran’s nuclear program has toughened. Rocket attacks from Gaza have resumed, though seem controlled. Developments overall are forcing the IDF to prepare to fight wars and defend against missile attacks on multiple fronts, which in the worst case scenario could deeply impact the domestic economy.

Despite geopolitical challenges, Israel’s economy chugs along—growing, stabilizing and strengthening. Furthermore, the global nature of Israel’s equity market makes it naturally diversified. A broad selection of Israeli stocks provides exposure to global economic activity and the growth and dynamism of Israel’s ‘best of both worlds’ economy. Israel’s technology sectors continue to drive technological advancement around the world. Lastly, Israel’s economic policy and regulatory environment—highlighted by the government’s move to break up multi-industry conglomerates, and the Bank of Israel’s astute monetary policy—should inspire confidence in investors.

Editor’s Note: Steven Schoenfeld, co-author of this article and the Founder and Chief Investment Officer of BlueStar Global Investors LLC, is also the Founder and Publisher of IsraelStrategist.com. Josh Kaplan is a Research Associate at BlueStar Global Investors LLC.

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