Josh Kaplan & Steven Schoenfeld: BlueStar Israel Equity Market Review and Outlook–Aug. 2012 in Review & Sept. 2012 Outlook
By Josh Kaplan and Steven Schoenfeld of BlueStar Global Investors LLC–September 13, 2012
This monthly column written by the staff of BlueStar Global Investors LLC discusses ideas and events related to Israeli equities traded worldwide. The relevant benchmark for this theme is the BlueStar Israel Global Index (“BIGI” BLS:IND on Bloomberg), which we believe represents the opportunity set of Israeli equity investments better than other benchmarks (such as the TA-25/TA-100 and MSCI Israel). It is becoming widely known that Israel has one of the most resilient economies in the world and that its technology sector plays an integral part in the global technological revolution. Fewer are aware of the global footprint of Israel’s companies in other sectors, and fewer still are aware of how to make their knowledge of the Israeli economy actionable. This column helps investors gain insight into the macro forces (including the geopolitical environment under which Israel’s economy operates) and the individual equity investment opportunities that have contributed to global Israeli equities’ outperformance of U.S. equities by nearly 1,500% over the past two decades.
One key reason why the BlueStar Israel Global Index (BIGI) is more relevant to North American investors than the TA-100 or MSCI Israel indexes is that BIGI includes Israeli companies that are listed on non-TASE exchanges, including NASDAQ, thus providing investors with a benchmark that is more actionable and better balanced across relevant sectors. (BIGI has a 31% tech weighting, while MSCI has a 13.5% tech weighting). In addition, BIGI caps the largest constituent by weight at 12.5%. (BIGI’s TEVA weight is 12.5%, while TA-100’s TEVA weight is 25%).
In each column, we discuss BIGI’s performance over the previous month, including the largest percentage gainers and losers, sector performance, and technical analysis; and key industry-specific and policy developments. We also touch upon relevant domestic and international current events. Readers are encouraged to take the trends and ideas presented in this column and take the time to research specific investment opportunities further.
“Finding their Footing”
In August, global and local Israeli equities were generally flat as markets continued bouncing along long-term support. However, many Israeli companies reported earnings and we gained a bit of clarity on the regulatory and policy changes affecting the government budget, the emerging energy sector, the telecommunications sector, and the banking and insurance sector. Though the global economic slowdown, looming corporate debt restructurings, structural reforms to Israeli corporate pyramids, and geopolitics still present major hurdles, we believe the events of August and early September have provided support for global Israeli equities.
BIGI (BlueStar Israel Global Index) Performance Versus the TA-100 and S&P 500 Indices Since 2010
Israeli equities, as measured by the BlueStar Israel Global Index (BLS:IND), were flat in August at -0.10%. Over the last few decades, global Israeli and U.S. equities have been positively correlated, though the growth nature of Israel’s economy has helped it outperform by a wide margin. In the past three quarters, however, Israeli equities have significantly underperformed U.S. equities, which we attribute to the “growing pains” of the Israeli economy and capital markets, troubles arising from the Euro Zone, and the “cold war” between Israel and Iran. However, as we have stated for the past several months, should there be a continuation of responsible fiscal and monetary management of the domestic economy, and firm responses in both Europe and the U.S. to major fiscal and monetary issues, a rally in risk assets (especially technology or growth-oriented equities) could be ignited and global Israeli equities could positively re-couple and outperform on the upside.
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.
August 2012 Sector Performance and Winners and Losers
As we discussed in last month’s column, the Telecommunications and Financials sectors led global Israeli equities lower for the third consecutive month in July. However, there were several bright spots for both sectors last month as the telecommunications companies led the TASE higher on several isolated instances and Deutsche Bank issued a report on Israel’s banks making the case that Israeli banks were undervalued and possibly oversold. We also noted last month that, if these two sectors, which have led Israeli equities lower, were indeed bottoming, it would be a positive sign for global Israeli equities as a whole. In August, the Financials were the greatest gaining group, up 0.44%, and the Telecommunications sector was the second greatest gaining group, up 0.40%. Additionally, positive regulatory developments regarding Israel’s emerging Oil & Gas sector emerged in August. The emerging energy industry in Israel has the potential to propel Israel’s already strong and dynamic economy onto yet more stable ground and into a steeper growth trajectory.
Regulatory headwinds continue to face the Financials sector. In August, the Bank of Israel began implementing recommendations of the Committee on Concentration in the Economy by ordering banks to eliminate certain fees, including fees for: information print-outs, cash withdrawal statements, handling of credit and guarantees, change of credit card payment date, management fees for small businesses, and capital market fees for managing short-term treasury notes and money market funds. The Bank of Israel is continuing to consider tightening mortgage restrictions, as the government raises its target budget deficit and the BOI lowers interest rates, in order to prevent an inflationary real estate bubble. Several investment houses in Israel noted in July that Mizrahi Tefahot Bank would be hurt the most by higher mortgage provisions required by lenders. However, shares of Mizrahi Tefahot Bank rose by over 3% in August–on 10% growth in total mortgages held by the bank in the first half of 2012 versus the same period a year earlier–and the bank experienced 17.1% net profit growth in Q2 2012 on a year over year basis.
Two key analyst reports on the Israeli banking industry were issued in August. First, a Deutsche Bank report titled “The Curious Case of Israeli Bank Valuations” reported that Israeli banks have underperformed even their European counterparts, which face more serious structural changes than Israeli banks do. The report also noted that Israeli banks have been among the worst performers in the world over the past year and current valuations are similar to valuations during the 2002 recession and the global financial crisis. Then on August 21st, UBS issued a report titled “The Bad, Good and Unknown of Israel’s Banks” in which it raised its recommendation on Mizrahi Tefahot shares, cut its recommendation on shares of Bank Leumi, and reiterated recommendations on shares of Bank Hapoalim and Israel Discount Bank.
Shares of companies in the Oil & Gas industry were up in August mostly on the recommendations of the Tzemach Committee, which has decided that gas partnerships will be allowed to export between 50% and 75% of gas reserves depending on the size of the reserve. The committee confirmed that the recommendations to allow this magnitude of exports will not harm the energy interests of Israel or its citizens. The report also allows for changes to the allowance of exports depending on future reserve estimates and updated reports regarding future domestic demand of natural gas. Factors that were holding back Israeli Oil & Gas exploration shares throughout the months before August include the recent recognition that a global oil major is needed to help finance and support the development of Israel’s Oil & Gas program and that, without the allowance of exports, there would be no economic incentive for an oil major to participate. Upon news of these recommendations, UBS issued a buy recommendation for all Leviathan partners and raised the price targets on the following companies substantially: It projected that Delek Group has a 60% upside, Avner- 72% upside, Delek Drilling- 67% upside, Ratio- 85% upside, and Isramco PT, a 25% upside.
However, there were two negative events of August and early September: no significant gas was found at the Myra 1 well, and ATP, which is Isramco’s partner at the Shishmon and Daniel fields, filed for bankruptcy and its licenses were taken back by the state of Israel. This could delay the development of these potential reserves by 1-2 years.
Profiles of Key Company Movers in May
Delek US Holdings is an oil refiner with U.S. operations in Texas and Arkansas. Upon completing the acquisition of Lion Oil, Delek US became an integrated energy company operating in three segments: refining, marketing, and retail. Recently, the company announced plans to spin off its subsidiary, Delek Logistics, in an IPO. Delek US shares had a sharp pull back from its 30% rise in the first weeks of August on account of an announcement by Delek Group that it is selling a small percentage of its ownership of Delek US. The announcement stated that Delek Group is a holding company which buys low and sells high, indicating that Delek US’s parent company feels its shares have become overpriced.
Partner is one of the major telecommunications service providers in Israel. Partner led all Israeli telecommunications companies higher in August despite its reported loss of 49,000 subscribers to new competitors and its Q2 2012 report that profits were down by 41% on a year over year basis. Unlike some of the other major telecommunications companies, Partner announced it would continue paying a dividend which, in light of lower profits, equates to a 60% payout ratio. The company is also excited about launching its 012 mobile brand and internet TV services.
Alon Energy USA (ALJ:NYSE) is an oil refiner and marketer in the U.S., with refineries spread across the country. After crossing its 200 day moving average in early July, it was among the NYSE’s largest percentage increasers several times during that month. In August, many U.S. refiners performed well and Alon Energy USA participated in that rally, building on July’s momentum.
Market Trends – Technical Analysis and Market Fundamentals
Technical Analysis of the Israeli Market
From a technical analysis perspective, Israeli stocks, as measured by the broad-based BlueStar Israel Global Index (BIGI), repeatedly tested key support during Q2 2012 around the index level of 195/200 (see solid red support line on two-year chart), and tested this level repeatedly in the past four months. As indicated by the solid black downtrend line on both the two-year and five-year charts, the short/medium-term outlook for Israeli stocks is challenging, especially with a breakout above the 225 index level needed to confidently reassert a bullish trend. The vital support levels of 194/197 just barely held during the summer and, while BIGI has reclaimed the 200 index level, it needs to hold above 200 during September and October to begin to consider that level as new support.
The longer-term outlook for Israeli equities could become bullish only if the index breaks back into the channel connecting the 2008/2009 lows, as illustrated in the BIGI five-year chart, which spans the entire 2008-2009 global financial crisis. This corresponds with the 225/230 level mentioned above. The first sign that this might be possible would be a pulse above 212/215 between now and the end of the Jewish Holiday season in early October.
As a big-picture review of the patterns on the long-term chart, 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, BIGI surged to lifetime 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 (solid red uptrend line), and the horizontal support zone dating back to autumn 2007 (solid red line), also at approximately the 195 BIGI level. As noted above, this level was repeatedly probed in June and July 2012, and again later in the summer, and appears to have held.
If the 200 level is maintained, a rally toward the downtrend line (solid black line) which began in mid-late 2011 at the 225/230 index level can occur. If this is broken, a rally to strong resistance is projected to be at 239/240, as highlighted by the solid green line. If this resistance is broken, we see the projected upside potential of the index to be at the 300 level by early-2013, though likely with a consolidation at the 2011 high of 275.
From a risk management perspective, the previously articulated stop-loss at the 192/194 level remains valid, but should be moved up to 195/197 level for the autumn. 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 195, the longer-term outlook will shift dramatically, and any rallies should be sold. A breach of 195/194/192 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. 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.
Last month we wrote the following, which is worth repeating this month. “In May 2012, the Israeli public’s financial portfolio consisted of NIS 374 billion of stocks, about 14.6% of portfolios. This is down from a year ago, though Migdal Capital Markets says that historically there has been an inverse relationship to the public’s exposure to the stock market and equity price performance. The Ministry of Finance is set to study the effects of the January 2012 5% increase in the capital gains tax on declining trading volumes, which have plunged over the past 12 months. In 2011, volumes on the TASE fell by 15% and volumes are down by a similar rate in the first half of 2012. One strategy for reviving trading volumes would be to include Israel in the MSCI Europe index. This would force index and portfolio managers to trade Israeli shares to gain the proper exposure to Israeli stocks.”
In a September 5th article, Globes revealed that non-Israelis invested a net $260 million in TASE-listed shares and $40 million in non-TASE listed Israeli companies in May and June 2012. If this flow of international funds into global Israeli equities continues, it could mean that significant reversal of the low volumes which have plagued global Israeli shares over the past couple of years is underway.
The main risk factors for global Israeli equities have been the European sovereign debt crisis and weak economic growth globally. The latter appears to be easing somewhat, and European debt and equity markets have rallied substantially in August and early September Other risk factors holding back global Israeli equities include regulation and policy issues; upcoming corporate debt restructurings; rising inflation expectations due to an increase in indirect (VAT) taxes, and the rising costs of energy and commodities; and the potential for a military conflict with Iran or one of Iran’s proxies. Considering the mix of slowing global economic growth and rising housing and energy prices, the Bank of Israel decided to leave its key interest rate unchanged for September at 2.25%. An additional domestic-oriented risk appeared in September – on the fiscal policy front – with the government still not producing a new budget prior to Rosh Hashana for the first time in many years.
Economic and Fiscal Outlook
In spite of the risk factors discussed in this essay, there were several bright spots for the Israeli economy reported in August. First, the annualized Q2 GDP growth rate was 3.2%–far above the expected 2.5%. More importantly, exports in Q2 2012 grew by 10.3% on an annualized basis and private consumption grew at 5.4%. These two GDP components were the biggest drags on GDP growth in Q1 2012 and were the basis for downward revisions to Israel’s 2012 and 2013 GDP forecasts by analysts and the Bank of Israel. Additionally, non-financial sector corporate debt issued in July was NIS 3.7 billion, which exceeds the 2012 monthly average of NIS 2.4 billion; the corporate debt market had been cooling down for several months.
In August, the Shekel continued to weaken and ended the month at a rate of NIS 4.03/ Dollar. Also, monthly layoffs hit a 3-year high in July as 16,000 Israelis lost their jobs and the unemployment rate rose 0.5%. Home prices rose 0.8% in Q2 2012 on a year over year basis, and NIS 4.9 billion in new mortgages were issued in July, which the Bank of Israel says does not necessarily indicate a new trend, but the Bank is keeping an eye on it.
On September 3rd, Moody’s investor services reiterated Israel’s A1 government bond rating and gave this rating a stable outlook “underpinned by the country’s high economic, institutional and government financial strength, but the rating is constrained by significant social and political challenges, which lead to moderate susceptibility to event risk.” This reiteration of Israel’s government bond rating is significant as fiscal policy and the growing government budget deficit have been taking center stage recently and have weighed on Israeli equities most significantly in July.
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 broad-based Israeli equity exposure potentially 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 nimble and effective 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.