Josh Kaplan & Steven Schoenfeld: BlueStar Israel Equity Market Review and Outlook–June 2012 in Review & July Outlook
By Josh Kaplan and Steven Schoenfeld of BlueStar Global Investors LLC for IsraelStrategist.com, July 10, 2012
This monthly column provides an overview of trends and developments in Israel’s dynamic economy and capital markets. It is written by key staff members of BlueStar Global Investors, a financial information firm focused on Israeli investment. It covers investment themes, industry sector developments, broad market trends, and individual company performance for potential investors, highlighting the many interactions between Israeli and global markets.
June’s major themes have been a continuation of May’s as regulatory, geopolitical, and other external factors influenced global Israeli equities. Regulatory and structural reforms aimed at increasing competition in Israeli consumer markets and separating the large ‘corporate pyramid’ industrial groups’ financial and non-financial operations are continuing to cloud investment decisions in Israeli public securities. In addition, the vacuum that was Egypt’s political environment before the Muslim Brotherhood won the presidential elections created geopolitical uncertainty. Last, but not least, the Euro Zone debt crisis continued through June and will continue to be a source of volatility for Israeli equities going forward.
Despite ongoing structural shifts, the Israeli economy remains strong, with prudent monetary and fiscal policy and high-tech innovation as its cornerstones. Also, the developing natural gas industry made great strides this month, and the prospect of an energy independent Israel is becoming more visible on the horizon.
BIGI (BlueStar Israel Global Index) Performance Versus the TA-100 and S & P 500 Indices Since 2010
During June, Israeli global equities as a whole, as measured by the BlueStar Israel Global Index (BLS:IND ), rebounded slightly from May’s sell off in the first few days of June before retracing nearly to last month’s lows. Over the past decade, Israeli, U.S., and EAFE equity markets have been positively correlated, with Israeli equities significantly outperforming most developed markets. It now appears as though the Israeli markets are becoming more aligned with non-U.S. equities; and as though the decoupling of the Israeli and U.S. markets that began nearly a year ago will continue 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, igniting a rally in risk assets, 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 investors with exposure to Israel’s economy as well as exposure to several diverse and globally-oriented economic sectors.
June 2012 Sector Performance and Winning/Losing Stocks
In June, Healthcare and Materials stocks buoyed the BlueStar Israel Global Index as all other sectors declined during the month (see table below). Perrigo and Kamada lead the healthcare stocks, gaining 13.51% and 8.08%, respectively. Teva, which is the largest Israeli company by market capitalization and holds the highest weighting in all major Israeli indices, recovered from a mid-month low of $37.40 to close the month at $39.44 on the NASDAQ.
All Materials sector stocks in the BlueStar Israel Global Index gained during June. This group was lead by Hadera paper, Israel Chemicals, and Cesar Stone, which had its IPO in late March 2012. These companies gained 8.40%, 5.66% and 3.58% respectively. Israel Chemicals, which is the largest Israeli company in this sector by market capitalization, has risen on increased fertilizer demand and a rise in international fertilizer companies. Also, Potash, a major U.S. fertilizer company, is continuing to seek a controlling stake in Israel Chemicals.
The Telecom and Financials sectors were the worst performers of June. The financials lead Israeli stocks’ decline in late 2011 and have been among the worst performers since then as regulatory burdens, structural changes to Israeli capital markets, and recent negative investment flows have become obstacles to banking, insurance, and financial conglomerates. This month, Clal Insurance, Jerusalem Economy Ltd., and Menorah Mivtachim led the group’s slide, posting losses of 20.23%, 17.94% and 17.02%, respectively. On the other hand, Israel Discount Bank, Airport City, Bank Leumi, and The Israel Corp all posted gains in June.
The Telecom Services sector was the worst performing sector in the first quarter of 2012 and continued to come under major pressure in June. All three Telecom Services companies in The BlueStar Global Index—Partner, Cellcom, and Bezeq—posted steep losses of 8.03%, 11.85%, and 14.13% respectively. The current major players are facing price competition from emerging players such as HOT mobile, Golan Telecom, and Rami Levy, which are offering inexpensive unlimited service plans.
Profile of Key Company Movers in May
SodaStream International (SODA:NASDAQ – up 32.16% in June) sells home beverage carbonation systems around the world. The company reported strong earnings and revenues in the first quarter of 2012 and has increased its full year guidance. Sodastream has been making headlines over its recent dispute with Coca-Cola. Coca-Cola confronted the Israeli company over its advertisements that laud Sodastream products for cutting back on waste, and compare them to Coca-Cola products, which produce waste in the form of plastic bottles and other containers.
Kamada (KMDA:TASE –up 8.08% in June) is a biopharmaceuticals company that develops, produces, and markets specialty, life-saving drugs. Its products are used to fight diabetes, respiratory conditions, infections, rabies, and blood-loss conditions, among other medical conditions. The company is developing ways to administer drugs through inhalation, rather than ingestion or injection, which is typically more comfortable for the patient.
Koor Industries (KOOR:TASE – down 28.07% in June) is one of the premier holding companies in Israel. Its holdings operate in agrochemicals, finance, technology, and venture capital. Koor is a subsidiary of Discount Investment Corp (DISI:TASE), which is a subsidiary of IDB Holding Corp (IDBH:TASE). It is thus part of one of Israel’s corporate pyramid structures. Koor experienced pressure this month as problems in Israel’s corporate debt markets persisted and on news that Credit Suisse, one of Koor’s main financial holdings, could suspend dividend payments.
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 in early June 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). 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 resistance is the previous two-year support at the 200 level (the lighter red line extending back to Q3 2010) with the 194/195 level (the dark red line) as critical support, which tenuously held in late June. If this latter level can hold, we should have the basis for a rally back at least to the 225 level. However, if the 195 level is breached (and this level was being probed again in early July as this report is written), the short-term outlook becomes grim, and we must look to the longer term five-year chart for guidance on the downside.
In May, we moderated our longer-term bullish outlook for Israeli equities because of the breach of the solid black uptrend line on the BIGI five-year chart below, which connects the 2008-2009 global financial crisis low with the mid/late 2011 bottoms. 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 threats of potential conflict 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. As noted above, this level has been continuously probed during Q2 2012, and was again being tested in early July.
From a risk management perspective, there is a clear “stop-loss” point at the 193/194 level. And, as noted in the short-term outlook, it was being aggressively probed in early June (as European markets were making new lows) and again in early July (as Europe and U.S. markets were weak, but not 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 decisively above the 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 later this summer. If the latter scenario develops, we would look for similar medium/long-term targets as were projected in our May Outlook, perhaps as high as the 270 level for BIGI.
Portfolio flows to Israeli markets have been mixed, with a decisive tilt toward fixed income. In the second week of June, Israelis increased their holdings of sovereign debt by 40% compared to the week prior. In that same week, equity funds experienced net redemptions of NIS 50 million despite gains in the major indices. Foreign investors, who on average added $110 million to TASE-listed shares in each month of first quarter of 2012, added only $60 million in April, and this important figure went negative in May, with a net outflow of $160 million.
The combination of bearish sentiment and negative portfolio flows induced by global macro storms, especially a contracting European market for Israeli exports, continues to be the number one risk factor effecting Israeli markets. For now, the secondary risk factors that could prolong the current downdraft are the regulatory burdens and structural reforms in Israeli capital markets. In June, the cabinet approved an economic concentration bill which will supposedly eliminate Israel’s corporate pyramids in 6 years; separate control of financial and non-financial institutions; and expedite the process of privatizing government-held industries and companies. The third risk factor in Israeli markets is geopolitical. The Bank of Israel has loosened monetary policy in light of slower growth in the CPI making monetary policy no longer a prominent risk factor for Israeli equities.
Economic and Fiscal Outlook
At the end of the first quarter of 2012, the Bank of Israel raised its 2012 GDP growth forecast to 3.1% from under 3%, and its 2013 GDP growth forecast to 3.4%. The Bank of Israel recently announced that the 2012 and 2013 GDP guidance remains unchanged. And in early June, the Organization for Economic Cooperation and Development (OECD) again praised Israel’s economic performance, especially relative to that of most European countries.
In 2012, the Bank of Israel lowered the benchmark rate twice, from 2.75% to 2.5% in the beginning of the year, and from 2.5% to 2.25% on June 25th. The latest decision was made in light of lower-than-expected growth in the CPI and a deteriorating situation in Europe’s debt debacle. The May CPI was unchanged and the annualized 2012 CPI growth figure is now 1.3%, within the target range of 1%-3%. Housing prices rose by only 0.3%, playing a neutral role in Israel’s CPI level.
Last month, the Israeli Shekel appreciated versus the Euro and depreciated versus the U.S. Dollar. Shekel appreciation last month began raising concerns about contagion from the Euro-Zone affecting Israeli exports to the country’s largest trading partner. In June, however, the Euro stabilized a bit and the Shekel weakened versus the Euro from a rate of 4.83 to finish the month at a rate of 4.93. The Shekel was mixed versus the dollar in June. It hit a mid-month high of 3.865 Shekel/Dollar but weakened after that to finish the month near its low of 3.947 Shekel/Dollar.
Additionally, the government doubled its target deficit to 3% of GDP (approximately NIS 14 billion) from 1.5% of GDP, sparking a debate between government officials and the ministry of finance as well as a review of Israel’s sovereign debt rating by Standard and Poor’s. As of April 2012, the unemployment rate in Israel was 6.7%, significantly better than the figures in most developed economies, including the US, Canada and the UK.
What to Watch For in Summer 2012:
1- Social Protests and Housing Prices: The protests that began in summer 2011 reignited recently in Tel Aviv and in some cases turned violent. High living costs and concentration of economic power are the legitimate concerns of protestors. The social protests of last summer prompted the government to take action on making Israeli financial and non-financial markets more competitive and consumer-oriented. Steps have also been taken to lower housing prices—the housing market has been one of the hottest markets in Israel over the past few years and a major source of contention among Israeli citizens, especially those in the younger demographic segments.
In The Bank of Israel’s May’s monetary committee meeting, it was affirmed that the higher level of housing starts indicated that no further steps by the Bank to cool the housing market are currently necessary. Even though new mortgages were up 37% in May over April, housing prices played an insignificant role in last month’s CPI figure. Housing prices in Q1 2012 were up 1% over Q4 2011, but down by 3% compared to Q1 2011.
Although housing prices seem to be steadying, rent as a percentage of income is still too high. The OECD assigned Israel last place in rooms per-person available and in percentage of net disposable income spent on housing: 50% of the new mortgage borrowers in May committed over 30% of their net disposable income to repayment of these mortgages.
2- Energy Sector: The electricity shortage and rise in electricity rates caused by the discontinuation of natural gas supplies from Egypt (natural gas comprises approximately 40% of Israeli sources of electricity production, and this rate is set to double in the coming decades) has prompted the government to take steps to expedite the development of Israel’s own natural gas fields. 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. June saw major progress in this arena and the momentum seems to be picking up: During our recent visit to Israel, we witnessed a noticeable increase in offshore engineering and a flood of construction workers arriving at Ben Gurion Airport for deployment offshore to build the rigs and pipelines needed to extract and transport Israel’s burgeoning gas finds.
In mid-June, the Public Utilities Authority approved a $20 billion, 15-year contract in which the Tamar Drilling Partnership (Nobel Energy, Isramco, Avner Oil & Gas, and Delek Drilling) will supply natural gas to the Israel Electric Corp. Following this deal, the Tamar partners signed an additional $3 billion gas supply deal with Dorad Energy, which is an Israeli independent power producer.
Additionally, Pinnacle, which is adjacent to Yam Tethys’ Mari B field, has begun producing 150 million cubic feet of natural gas per day which, according to a Globes’ June 13th article , will save Israel NIS 650 million in this coming summer alone. Gas also started flowing out of the Noa North field. Israel Opportunity, which is a limited partnership of oil and gas explorations, has increased estimates of reserves in the Pelagic field to 530 million barrels of oil and 5.5 trillion cubic feet of natural gas. Some of the gas from the Pelagic field may be sold to Cyprus as Cyprus’ natural gas fields will take more time to develop.
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 Greek austerity and Spain’s bank and financial sector woes; a stronger bi-lateral exchange rate; and a contracting Euro-Zone economy, remain the single biggest sources of pressure on Israel’s economy and GDP.
4- Debate over Budget Deficit and Fiscal Policy: The Government has proposed a significant increase in the budget deficit, from 3% perhaps up to 6%. This has raised alarm bells in the Bank of Israel, as well as external credit rating agencies. While the Prime Minister and Finance Minister remain committed to fiscal restraint, a move of this size could impact Israel’s external funding costs, and will surely be robustly debated during the summer.
5- Geopolitics: The situation in Syria has deteriorated further as military attacks on civilians continue and refugees flee to Turkey. Additionally, Syrian forces shot down a Turkish jet and supposedly shot at another because it might have invaded Syrian airspace. The American and Israeli stances on Iran’s nuclear program have toughened and the U.S. recently stated that a military option is not only on the table but that a strategy is also ready and actionable if necessary. The latest round of diplomacy between world powers and Iranian officials proved to be fruitless.
The longstanding peace treaty between Israel and Egypt has been a key source of stability in Israel’s economy over the past several decades. During June, however, terrorist and rocket attacks from the Sinai Peninsula and the Gaza strip continued. The consequences for Israel of the Muslim Brotherhood’s victory in Egypt’s first democratic elections are uncertain: will Mohamed Morsi, the newly elected president, uphold the peace treaty, continue relatively unhampered trade between Israel and Egypt, and continue to allow Israeli ships access to the Suez Canal? Or will the new government form closer ties with Hamas in the Gaza strip and Iran in an attempt to destabilize Israel? We expect a little of both, but with much uncertainty, and a likelihood that Israel will have to spend much more on defense of its borders with Gaza and the Sinai.
Yet amidst significant 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—which includes InfoTech, AgriTech and DefenseTech—continues 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.