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Josh Kaplan & Steven Schoenfeld, BlueStar Global Investors: BlueStar Israel Equity Market Review and Outlook–May 2012 in Review & June Outlook

Published on Jun 07 2012 // Columnists

June 7, 2012

This monthly column written by the staff of BlueStar Global Investors, a financial information firm focused on Israeli investments, provides an overview of trends and developments in Israel’s dynamic economy and capital markets. It introduces themes, sector developments, market trends, and individual company performance to potential investors, highlighting the many interactions between Israeli and global markets.

A Bearish Month

In May 2012, the external shock of the accelerating Eurozone crisis combined with domestic policy and regulatory changes rocked the boat severely for Israeli equities. Domestic structural reforms geared at increasing competition in Israeli consumer markets and break up of large ‘corporate pyramid’ industrial groups have created turmoil in the local capital markets. Israeli conglomerates have suffered financial distress.

But we strongly believe these reforms are necessary and that they will have a net-positive impact on Israel’s economy and, in the longer-term, its financial markets. In addition, we believe that the Bank of Israel will take the steps necessary to guide the economy through the stresses in financial, industrial and consumer, and foreign exchange markets. In its latest decision, the Bank held interest rates steady. (More on monetary policy below.)

During May, the BlueStar Israel Global Index (BIGI), the broadest and deepest benchmark of Israeli equities, lost 11.54%, while the local Tel Aviv-100 lost 8.20%, and the MSCI Israel Index lost 13.35% (see chart, below). Israel underperformed the broad spectrum of Developed Markets in May, with the S&P 500 losing 5.78% and the MSCI EAFE, a broad gauge of Developed Markets outside the U.S., losing 11.14%. Emerging Markets lost 12.15% during the month, as measured by the MSCI EM index.

            Source: BlueStar Global Investors LLC


Over the past decade, Israeli and U.S. equity markets have been positively correlated, with Israeli equities significantly outperforming U.S. equities. It now appears as though the decoupling of the Israeli and U.S. markets, which began in 2011, will continue for some time, as long as the challenges discussed in our broad market analysis (below) continue to exist. If there is a firm response in both Europe and the U.S. to major fiscal and monetary issues, Israel could ‘positively re-couple,’ and potentially outperform on the upside. Despite the country’s relative short-term underperformance, the broad Israeli equity universe – which includes companies listed in Tel Aviv, the U.S., and elsewhere – provides exposure to eleven diverse and globally-oriented economic sectors, and has produced dramatic outperformance relative to major Developed Markets during the past ten years.

May 2012 Sector Performance; Winners and Losers

 

Sector

As defined by BlueStar Indexes

May 2012 Performance

Consumer Staples

-0.26%

Construction and Real Estate

-0.32%

Materials

-0.34%

Technology

-0.36%

Energy and Exploration

-0.63%

Telecom Services

-1.02%

Industrials

-1.04%

Consumer Discretionary

-1.44%

Financials

-1.90%

Healthcare

-2.05%

Information Technology

-2.19%

 

In May, no sector within the BlueStar Index benchmark had gains. Leading the market slide was the Information Technology sector, which collectively lost -2.13%.  (For an assessment of the first quarter of 2012, see the BlueStar Review and Outlook published in April). Within the Israeli Information Technology (I.T.) space, Mellanox Technologies stood out as the sole advancer, gaining 3.17%. Tower Semi Conductor, Click Software and Check Point were the worst performers, losing-2.68%, -20.78%, and -11.85%, respectively.

The reversal of the I.T. sector is alarming because this sector led the broader market in its 2010-mid 2011 advance, and stood out as the only gaining sector in Q1 of 2012. Reasons for the sector’s losses include the Eurozone debacle, which has led to shekel appreciation versus the Euro and is affecting Israel’s net exports. In addition, slower global economic growth is weighing on the prospects of a prolonged expansionary business cycle within which I.T. companies would perform well.

The Banking and Financial sector continues to undergo pressure despite a correction during Q1 of 2012. Among the worst Financial Sector performers in the BlueStar Index during May were Bank Leumi, Harel Insurance Investments, Israel Corp, and Mizrahi Tefahot Bank, which lost -16.53%, -12.26%, -10.98%, and -8.94%, respectively. Continued 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. Some analysts say that the anticipated credit crunch in Israel has arrived. In Q1, housing starts were down by 11.00% (on account of the inability for some builders to find the financing needed for projects), and credit to the business sector from Israeli banks declined 0.9%.

The Telecom Services sector provides a prime example of how continued regulatory changes may have a dynamic effect on Israeli markets. One of the biggest economic stories of the year in Israel has been the public’s pressuring of the Israel government to reduce the concentration of economic power in the hands of leading Israeli industrial groups and the ‘tycoons’ which head them. In response to public demands, the government formed a Committee on Market Competitiveness that has focused broadly on the problems surrounding industrial groupings, but has zeroed in on particular sectors.

Telecom companies were among the biggest decliners in the past half year and many of the major telecom companies continue to slide. But the sector seems to have found at least a short-term bottom. Two new competitors in the marketplace, HOT Mobile and Golan Telecom, are offering extremely competitive rates for unlimited telecom service contracts and are forcing the bigger players like Cellcom, Partner, and Bezeq to offer lower priced service plans. Increased competition has resulted in tangible benefits to the Israeli consumer. As the Telecom story continues to unfold, we will see if the sector will continue to fall, if it has found a bottom, or if markets overreacted. Russian mobile carrier Mobile Telecom Systems seems to think the market has overreacted to the fall in Partners’ stock price–the two companies have recently entered into acquisition talks. Additionally, Deutsche Bank released a report in mid-may stating that it sees at least 40% upside potential in Bezeq’s stock price, and HOT mobile announced it will be buying back shares at a premium.

 

Top-Performing Israeli Stocks in May 2012

Worst-Performing Israeli Stocks in May 2012

Ormat Industries

11.51%

Discount Investment Corp

-58.49%

Live Person

8.69%

Kardan NV

-56.26%

Formula Systems

3.31%

IDB Holding Corp.

-46.05%

Mellanox Technologies

3.17%

Cellcom

-41.03%

Ormat Technologies

2.73%

Partner Communications

-37.88%

Syneron Medical

1.53%

Verifone Systems

-24.20%

Kamada

1.00%

Tower Semiconductor

-22.68%

Frutarom

0.89%

Ceva Inc.

-21.32%

ClickSoftware

-20.78%

Elbit Imaging

-20.33%

Source: BlueStar Global Investors LLC

 

Profile of Key Company Movers in May

Ormat Industries (TASE: ORMT – up 2.7% for the month) develops, designs, constructs, and operates electric power plants, and manufactures and distributes equipment worldwide. The company’s power plants produce electricity from geothermal sources of energy. Ormat is also engaged in production of wind turbines and the research and development of biodiesel from vegetable and animal sources. The company’s activities are global in reach; it does business in North America, Latin America, South East Asia, and Europe. In the first quarter of 2012, Ormat’s revenue rose 33% on a year-over-year basis, and net profit jumped approximately 40% in the same period.

Live Person (NASDAQ: LPSN – up 8.7% in May) enables businesses and institutions (including retailers, telco’s, education facilities, hospitality facilities, government institutions, etc.) to engage customers and provide customer support online. The company hosts platforms which support online transactions for businesses. An example of Live Person’s service is real-time customer support at the point of an online sale through a small instant message or chat window on an online retailer’s website.

Formula Systems (NASDAQ: FORTY; TASE: FORT– up 3.3% for the month) is primarily a software developer and software consultant. The company has customers in over 50 countries around the globe. In the first quarter of 2012, Formula Systems reached an all-time high with revenues of $178 million. Net income increased by 87% in the first quarter on a year-over-year basis, and all of Formula’s subsidiaries reported strong first quarter growth.

Broad Market Trends – Technical Analysis and Market Fundamentals

Technical Analysis of the Israeli Market

Israeli stocks, as measured by the broad-based BlueStar Israel Global Index (BIGI), suffered a relentless decline in May, but found support at key technical levels that were tested and held in late 2011 and early 2012. BIGI found support during Q1 2012 around the index level of 200 (see the lighter solid red line on the two-year BIGI chart below). However, while the short term outlook for Israeli stocks looked promising in April and early May, the tentative breakout above the 225 index level noted in last month’s outlook proved to be a false one – and quite short-lived. The upward trend line (dotted black line) that began earlier in 2012 was rapidly breached in May, and BIGI plummeted along with European and global equities. The short-term prospects for the market are now at a critical inflection point; a mildly bullish outlook could be maintained as long as support levels from early this year are not breached, but this view is now tenuous. The key short-term support levels are the two-year support at the 200 level (the lighter red line extending back to Q3 2010) and at 195 (the dark red line) below. If these levels hold, we should have the basis for a rally at least back to the 230 level. However, if the levels are breached (and they were being probed as this report is written, in early June), the short-term outlook becomes grim, and we must look to the longer term five-year chart for guidance on the downside.

Source: BlueStar Global Investors LLC

 

In April, we noted that the longer-term outlook for Israeli equities was 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 lifetime highs in late 2010 through Spring 2011, only to correct deeply again amidst Europe’s financial crisis, Israel’s domestic social protests, and nuclear threats from Iran.   BIGI 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.

Source: BlueStar Global Investors LLC

 

From a risk management perspective, there is a clear “stop-loss” point at the 192/195 level zone. And, as noted in the short-term outlook, it was being aggressively probed in early June (as European markets were making new lows). If these levels are breached and confirmed with a weekly close of BIGI below 192, the longer-term outlook will shift dramatically, and any rallies should be sold. A breach of 192 will increase the likelihood that the spring 2011 peaks represent the ‘head’ of a massive ‘head and shoulders’ pattern which would project a major decline to around 135, just above the autumn 2008/March 2009 lows. However, if these levels hold, and a rally can lift BIGI off the 195/200 level, there is some hope that this major multi-year support level will have held, and can potentially form a base for a sustained rally this summer. If the latter scenario develops, we would look for similar medium/long-term targets as were projected in last month’s Outlook, perhaps as high as the 270 level for BIGI.

Fundamental Outlook

The primary risk factor to the Israeli market is a contagion of bearish sentiment and negative portfolio flows induced by global macro storms. The secondary risk factor that could create a prolonged downdraft is geopolitical, as monetary tightening seems to be less likely with current shekel appreciation and a credit crunch. Also, preliminary regulatory burdens seem to be built into market prices already. The Q1 2012 earnings season was generally quite disappointing. The major banks reported earnings on May 31 with a significant fall in profits. Teva lowered its full year 2012 profit forecasts as did several other major Israeli companies.

Economic and Fiscal Outlook

A shift in Israel’s net-exports was a moderating factor in the country’s 4.7% GDP growth in 2011 as the shekel strengthened and Eurozone economic contraction weighed on Israel’s foreign trade. At the beginning of 2012, the Bank of Israel forecasted 2012 GDP growth to be under 3% and it 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. At the beginning of 2012, the Bank lowered its benchmark rate from 2.75% to 2.5%. It has recently decided to maintain the 2.5% rate in light of developments in the European Union. And in early June the OECD again praised Israel’s economic performance, especially relative to that of most European countries.

As for the Shekel, the situation in the Eurozone is continuing to weigh on the Euro versus many currencies, including the New Israeli Shekel. As of May 31, the shekel-euro exchange rate was NIS 4.80/Euro and the shekel-dollar rate was NIS 3.875/Dollar. The trend of the Shekel gaining on the Euro is continuing, and it will continue to affect Israel’s export sector, upon which GDP growth is dependent.

Additionally, the government of Israel is planning a budget cut of approximately NIS 10 billion to help recover some of the deficit created by expansionary fiscal policy in recent years. Though this move is politically difficult, government officials believe GDP growth and unemployment are strong enough to bear the weight of the budget cuts.  In April, the unemployment rate fell to 6.7% from 7.1% in March.

What to Watch For in Summer 2012

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. Tightening monetary policy in 2011 and recent regulatory changes in mortgage origination helped to ease the rise in housing prices.

Housing Minister Ariel Atias sees the Bank of Israel as having forced somewhat of a credit crunch. This credit crunch, he believes, is in part responsible for the fact that housing starts were down by 11% in the first quarter of 2012. (Additionally, a recent OECD report on housing shows that Israel is ranked among the lowest of OECD countries in rooms per-person and in percentage of net disposable income spent on housing, at 22%.)

2- Energy Sector: The continual rise of electricity rates (estimated at 8.9% in April 2012) has underscored the need for Israel to develop natural gas fields. In the last several months, the pipeline serving Israel and Jordan has been attacked repeatedly. In addition, a supposed dispute over payments between Egypt and an Israeli company has resulted in Egypt cancelling its natural gas supply contract with Israel.

The natural gas industry has the potential to transform Israel’s macro-economic and geopolitical situations. A domestic natural gas program and a natural gas export industry can help ease rising electricity rates and provide a major source of GDP growth and tax revenue. For example, Israel Electric Corp, the virtual sole provider of electricity in Israel, stated that its expenditure on fuels more than doubled in the first quarter of 2012, which translates into higher energy costs for Israeli businesses and consumers. Noble Energy, along with Delek Group, is expediting the laying of an underwater natural gas pipeline in order to meet its commitment of supplying Israel with natural gas from the Tamar field by 2013. During our recent visit to Israel, we witnessed a noticeable increase in offshore engineering and construction workers arriving at Ben Gurion Airport for deployment offshore to build both the rigs and the pipelines to extract and transport Israel’s burgeoning gas finds.

3- Spillover impact from European markets and economies: While Israel’s trade flows between North America, Asia, Emerging Markets and Europe are quite balanced, the European market remains the largest single market for many Israeli exports. Continued economic weakness in Europe–highlighted by the prospect of Greece exiting the Eurozone and Spain’s mounting bank and financial sector woes–could dampen Israel’s output, and sharp drops in European markets could also have an impact on Israel’s stock market.

4- Geopolitics: The situation in Syria is getting worse and the American and Israeli stance on Iran’s nuclear program has toughened. Despite the current round of diplomacy, it seems as though both Iran and the U.S. and its allies are unwilling to compromise on the key issue of Iran gaining nuclear capabilities. The U.S. has also stated that a military option is not only on the table but that a strategy is also ready and actionable if necessary. Rocket attacks from Gaza which resumed during the first months of the year have ceased. But developments overall are forcing the IDF to prepare to fight wars and defend against missile attacks on multiple fronts, which could potentially paralyze the domestic economy–not to mention the Navy’s task of protecting Israel’s natural gas reserves.

Despite geopolitical and global economic challenges, Israel’s economy continues to outperform its OECD peers, as well as many Emerging Markets. Its equity market has, unsurprisingly, been buffeted by Europe’s economic crisis and the global downtrend in stock markets. However, the long-term attraction of Israeli stocks remains intact, and the global nature of Israel’s equity market makes it naturally diversified vis-à-vis regional tensions in the Mideast. We continue to believe that a broad selection of Israeli stocks provides exposure to both global and domestic growth. Such a portfolio offers ‘the best of both worlds’ — Developed Market stability, and the demographics and growth potential of an Emerging Market. In addition, Israel’s high-tech sector – InfoTech, AgriTech and DefenseTech – continue to drive technological advancement around the world. Finally, 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 the long-term confidence of 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. He is the Editor of Active Index Investing (Wiley Finance 2004/Toyo-Keizai 2006/China Press 2009). Josh Kaplan is a Research Associate at BlueStar Global Investors LLC.

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