Josh Kaplan & Steven Schoenfeld: BlueStar Israel Equity Market Outlook–Dec. 2012 in Review & Jan. 2013 Outlook
By Josh Kaplan and Steven Schoenfeld of BlueStar Global Investors LLC-–January 16, 2013
This monthly column produced by BlueStar Global Investors discusses Israeli equities traded worldwide. The relevant benchmark for our review is the BlueStar Israel Global Index (“BIGI” BLS:IND on Bloomberg), which we believe represents the complete opportunity set of Israeli equity investments.
Israel has one of the most resilient economies in the world and its technology sector plays an integral part in the global technological revolution. Too few 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 company 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 exchanges outside of Israel, including NYSE and Nasdaq, thus providing investors with a benchmark that is balanced across key sectors. (For example, 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% to attenuate the impact of any single stock on the index.
In this column, we discuss BIGI’s performance over the previous month, including the largest percentage gainers and losers, sector performance, technical analysis, and key industry-specific and policy developments. We also touch upon relevant domestic and international economic and geopolitical events. Readers are encouraged to use the trends and ideas presented in this column and take the time to research specific investment opportunities further.
Lifting off from a Solid Foundation
Global Israeli Equities consolidated in December after breaking through multi-month highs in November. December saw macro-economic developments more than equity-specific developments; for example, the Bank of Israel, the Ministry of Finance, and several investment houses began publishing 2013 forecasts focused on GDP growth, budgetary concerns, and currency trends. From an Israeli Global Equity perspective, we saw a continuation of the encouraging trends that helped Israeli equities turn around in mid- 2012—like recovery in financials and leadership in the oil and gas sector–and we also saw bottoming formations in several of Israel’s high tech and pharmaceutical companies.
After Operation Pillar of Defense, Israel’s short-term geopolitical focus shifted from military conflict with Hamas to the renewed international pressure on the state of negotiations with the Palestinians.
We continue to be bullish on Israeli Global Equities based on economic forecasts for 2013 and 2014, our technical analysis of the market and individual securities, and a broader bullish view on the global equity asset class. We still expect that significant volatility during 2013 will derive from budgetary and regulatory issues as well as softening domestic consumption.
BIGI (BlueStar Israel Global Index) Performance Versus the TA-100 and S&P 500 Indices Since Jan 1 2010
Israeli equities, as measured by the BlueStar Israel Global Index (BLS:IND), were essentially flat in December, losing 0.09% after rising nearly 5.5% over the previous two months. Israeli Global Equities gained 8.63% in 2012. Israeli Global Equities outpaced Israeli “local” equities by a wide margin in December as the TA-100 index lost 3.7% and the MSCI Israel index lost 6.3%. Israeli equities as a whole, however, underperformed most other developed and emerging markets in December. We continue to expect Israeli equities to play catch-up to other global equity markets in 2013 and beyond. Israeli equities underperformed global equities in 2011 through 2012 despite faster economic growth and more stable economic fundamentals. We attribute this mostly to the trend of lower volumes on the local Tel Aviv Stock Exchange and the geopolitical events of 2012.
The broad Israeli Global 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 vibrant and globally-oriented economic sectors.
December 2012 Sector Performance and Winners and Losers
The Financials continued to lead Israeli Global Equities in December, playing out according to our prediction in October’s column that Financials would continue to gain but at a slower pace. They gained 0.87% in December, after gaining 1.17% in November and 2.14% in October. The rise in Financials was broad-based: again, 19 out of the 21 Financials stocks gained in December. Many Israeli financial companies are holding companies and real estate companies which enjoy stock price appreciation when the general economy is growing and stable. Israel’s banks, however, are gaining recognition for their financial strength and low valuation relative to international peers. The Banks’ new capital adequacy ratio target is now 12.5% and will be 13.5% by 2017. Bank Hapoalim’s capital adequacy ratio is Israel’s highest at 15.1%, followed by Bank Leumi’s at 15.02%, Israel Discount Bank’s at 14.2% and Mizrahi Tefahot’s at 13.11%. Additionally, the Bank of Israel agreed to allow banks to recognize deferred taxes as part of a bank’s capital. The banks’ strong performance along with the general feeling that interest rates will rise again towards the end of 2013 are strengthening the position of banks to increase their loan activity. Lastly, with the Bank of Israel lowering interest rates, there has been a thawing of the credit freeze, allowing Israeli companies to refinance their debt and lower their risk of default.
We continue to hold an overweight position in the Financials sector for the reasons stated above and previously in this column over the past several months. We are also encouraged to have seen net inflows to mutual funds and an overall rise in Israeli equities last month. The biggest risk here would be a sudden drop in housing prices, increased mortgage restrictions, or some sign that the mortgage restrictions already imposed are beginning to have a meaningful effect on banks’ mortgage lending practices.
Consumer Services stocks were lead by Delek Automotive Systems and SodaStream International. SodaStream rose by over 30% since its bottom in mid-November. SodaStream seems to be behaving like a “perfect stock” breaking through 52-week resistance, with a PE:G ratio averaging below 0.5, a nearly 50% short interest with over 9 days to cover ratio and a sub 5% penetration rate in the U.S.. We believe that the airing of a SodaStream commercial during the Super Bowl in early February could be an additional catalyst for the company’s brand recognition and growth.
Israel’s Health Care stocks were the worst performers in December. The decline in Health Care stocks was lead by Clal Biotech Technology Industries, Teva, and Protalix. Teva is the largest Israeli company and its December decline attributes for a large share of most Israeli equity index declines. In the first few days of the month, UBS downgraded TEVA from “buy” to “neutral.” Shortly after, the FDA denied Teva its Copaxone generic trial petition. Later in the month, Teva’s CEO announced a new strategic path for the company. The company will transform Teva from a “dynamic generics company” into a “diversified international pharma company.” This means shifting focus from acquisition-based growth to organic growth and building sustainable shareholder value. The company is targeting return to investors and plans to carry out a share buyback program. This strategy may force Teva’s growth rates down in the short run but, in the long run, it might help the global pharmaceutical giant grow in a more sustainable way.
Protalix was denied marketing authorization for an enzyme replacement therapy for Gaucher’s disease in early November. However, in December, the company announced it was close to signing an agreement with the government of Brazil worth hundreds of millions of dollars, and it signed a deal with Pfizer to further test its Gaucher’s disease product.
As has been the case over the past several months, there was continuous news flow in December about Israel’s emerging natural gas and Energy sector. It is expected that natural gas from the Tamar site will be marketed in Israel beginning in mid-2013, and that gas from the Leviathan will be delivered in 2016 through a port in the north.
The immediate effect of Israel’s natural gas on GDP forecasts is interesting. The Ministry of Finance predicts that Israeli GDP will grow by 3.5% in 2013 and 3.9% in 2014. The Bank of Israel predicts that GDP growth in 2013 will be 3.8%, while investment houses like Merrill Lynch and Barclay’s predict 3% growth. It is widely understood that natural gas will contribute to nearly 1% of this growth through the substitution of imports by domestic production and investment expenditure. Though analysts and officials say that, despite this boost to GDP growth, the effect of the natural gas on unemployment and the labor market will be limited. As a result, some analysts are taking off 1% of their GDP growth forecasts when modeling for 2013.
From an equity investment perspective, one way to proceed would be to continue overweighting the energy sector. Growth in this industry may not immediately lead to a multiplier effect through the broader economy. Instead of a portion of revenues flowing into the pockets of would-be employees and the government through taxes, a portion of revenues will flow into companies’ balance sheets or will be spent by them to invest in growth-yielding projects. For this reason, holding an overweight position in Israeli energy equities and LP’s will aid in insulating investors from lower-than-expected economic growth in Israel.
Other Energy sector headlines in December included:
- Woodside met with representatives of Pelagic permits to discuss partnership
- Ratio announced that Italy’s Edison International SA will be operating partner for Gal permits
- Noble Energy is to deliver 750 MCF of gas each day beginning in 2016 via a northern entry point
- Oil prospects at Leviathan are to be explored beginning late 2013
- Tamar partners signed $400 million supply contract with Dor Alon for 1.68 BCM of gas over 15 years
- IEC threatens to cancel Tamar contracts unless the Gas authority reverses decision on supply to small manufacturers
- Shemen oil is preparing to drill Israel’s first offshore oil well with best estimates of 120 million barrels of oil and 1.8 TCF of gas
- Ishai reserves are much smaller than anticipated
- Modiin Energy to raise NIS 75.5 million in secondary offering
- Ministry of Energy and water resources awarded gas storage license to joint subsidiary of Delek Group and Noble Energy
Profiles of Key Company Movers in December
Alon USA Energy (ALJ:NYSE) gained 27.22% after recently spinning off its subsidiary, Alon USA Partners LP. Alon USA Energy is an independent refiner and marketer of petroleum products in the South Central, Southwestern, and Western U.S. The company produces gasoline, diesel fuel, petrochemicals, petrochemical feed stocks, asphalt, and others. Prospects for oil refiners in the U.S. are bright because oil production is increasing , lowering oil prices, which is a catalyst for refiners. Keep an eye on Delek US Energy (DK:NYSE)–this stock has broken out of a 6-month consolidation in early 2013.
Hadera Paper (HAP:TASE) is a leader in the paper and paper products market in Israel. The company has partnerships with various leading international enterprises and is engaged in the manufacture and sale of a broad range of products including: printing and writing paper, packaging paper, corrugated board, household consumer products, hygiene products, and additional disposable consumer products. The company also markets office supplies to the institutional and business sector.
Delek Automotive Systems (DLEA:TASE) is a subsidiary of Delek Group and wholly owns Delek Motors Ltd. Delek Motors has been the exclusive importer and distributor of Mazda cars in Israel for over two decades and has also been the exclusive importer of Ford and Lincoln since 1999. In 2011, Delek Motors acquired Kamor Motors Ltd, which was the exclusive importer and distributor of BMW cars in Israel.
Market Trends – Technical Analysis and Market Fundamentals
Technical Analysis of the Israeli Market
The technical picture for Israeli stocks, as measured by the broad-based BlueStar Israel Global Index (BIGI), consolidated throughout December after breaking through important trend lines, holding key support levels, and breaking through multi-month highs in November. In early November, Israeli stocks failed to break the 220 resistance level represented by the dotted green line on the two-year chart. Instead, as Operation Pillar of Defense progressed, Israeli equities retreated to the key technical area of 200-205. The market quickly recovered, confirming that the 200 index level is a strong area of support for the index, coinciding with the multi-year thin red support line. This area was confirmed after a test of the former downtrend line which was broken in October/November, and it also coincides with the relatively new black uptrend line originating with the Q3 2012 low. As December was a relatively quiet month after the roller coaster of November, we view the consolidation near the 220 level as constructive to our overall bullish view of Israeli Global Equities.
The short-term outlook for Israeli Global Equities is now solidly bullish, though there is always the chance that the Index will come back in to retest the new uptrend line. If there are no negative catalysts, we expect the upward momentum to carry Israeli equities higher to strong resistance near the 230 level.
The longer-term outlook for Israeli equities is still cautiously bullish and will become more bullish only if the index breaks back into — and ideally through — 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 220-225 levels mentioned above. BIGI breached the lower band of the channel but did not break through it in October, and subsequently dropped back to test the 200 level, as noted above.
If BIGI enters into and remains within the aforementioned channel, a rally to strong resistance is projected to be at 239/240, as highlighted by the solid green line on the five-year chart. If this resistance is broken, we see the projected upside potential of the index to be at the 300 level by mid 2013, though most likely following a consolidation at the 2011 high of 275.
From a risk management perspective, the revised stop-loss at the 195/197 level articulated in our September and October Outlooks remains valid, but those with a shorter-term perspective should move their stop-loss higher to 205/210 in BIGI as we begin the new year. Investors can also view a pull-back below the newly established upward trend line, currently at the 208-210 level, as a warning signal. If these levels are breached and then 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 would 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, as these higher stop-loss levels have so far held, a rally of BIGI decisively above the 220 level, this would confirm that this major multi-year support level will have held, and will potentially form a base for a sustained rally. If the latter scenario develops, we would expect medium and long-term targets as high as the 275 and 300 levels, respectively.
As declining trading volumes on the TASE continue to hurt Israeli capital markets, we continue to monitor portfolio flows in terms of both net international investment in capital markets and asset allocation among the local markets. One strategy for reviving trading volumes which we’ve discussed in prior months would be to include Israel in the MSCI Europe index. In December, Excellence, an Israeli investment house, said that Israel could join MSCI Europe by the end of 2013. If this happens, there could be a $2 billion flow of capital into Israel’s capital markets. Another strategy to revive TASE trading volumes, which involves extending trading hours to 5:30 pm, was discussed by the CEO of the TASE. Extending trading hours would allow traders in international markets more overlap in trading times.
There was some positive news in December concerning Israel’s debt markets. In Q4 2012, over NIS 5 billion in corporate debt was raised and overall bond prices jumped. There has been a drop in yields on TASE-listed bonds which has allowed good companies to come to market and raise debt at fairly low prices. The biggest bond offering by a non-government company was by Gazit Globe, which sought NIS 500 million and was oversubscribed by NIS 1.3 billion. Gazit Globe took the opportunity to strengthen its financial base by NIS 1 billion.
Developments in the international arena included the passage in the UN of an Israeli resolution on using entrepreneurship as a means of fighting poverty and promoting economic development. The Prime Minister deferred the signing of an open skies agreement with the EU due to upcoming elections. The Finance Ministry is talking to the US Treasury Department to allow reciprocal transfer of bank account information to help Israeli banks deal with strict US regulations. Teva is entering a partnership in South Korea; Photomedix extended an agreement with a Japanese distributor; and Microsoft’s Israel incubator opened its second session–graduates of the first session have raised $6.5 million in the three months since the session ended. Singapore’s government VC fund will invest in Israel; the fund has $150 million in AUM and will collaborate with Rosario Capital.
On the geopolitical front, tensions have diminished between Israel and Hamas in Gaza. Israel and Egypt are now allowing more construction materials to enter into Gaza and, if the calm persists, more eases will follow. There is increasing international pressure on Israel over building in the contested or “settlement” areas. Australia and Brazil have become the latest countries to summon envoys over the issue, and the EU said that all of its economic agreements with Israel must “unequivocally and explicitly indicate their inapplicability to the territories occupied by Israel in 1967, namely the Golan Heights, the west bank, East Jerusalem, and the Gaza Strip.” Lastly, on a positive note, Turkey will allow the resumption of NATO cooperation with Israel as a third-country NATO partner.
Economic and Fiscal Outlook
Preliminary reads on 2012 GDP came out in December. GNP in 2012 was NIS 930 billion which equates to 3.3% growth over 2011 compared to 4.6% growth in 2011 and 5% growth in 2010. Israel’s economic growth rate is among the highest of developed countries and more than double the OECD average. Per capita GDP growth was also nearly double the OECD average.
The Bank of Israel lowered its policy interest rate in December by 25 bps to 1.75%. The reasons for this decision were that the BOI wanted to give growth a better chance in light of November CPI declining by 0.5%, and an apparent slowdown in the rise of housing prices. In light of slow global economic growth and other central banks also lowering rates, the BOI also found it prudent to give a jolt to economic growth and help exporters fight the appreciation of the shekel. However, the shekel seems poised to continue to gain ground despite the lowered rates. Many analysts, including personnel at the Bank of Israel, expect the bank to lower rates once again in 2012 before raising rates towards the end of the year.
The deficit in government activity was NIS 21.2 billion from January through November 2012. This is NIS 8.7 billion greater than the forecast. The deficit for the full year is expected to be 4.1% of GDP. The fiscal package approved by the Knesset in mid-2012 came into effect on January 1, 2013. The package includes tax hikes on the middle and higher tax brackets and lowers the threshold for inclusion in higher tax brackets. Also in December, the Ministry of Finance approved NIS 740 million in budget cuts. The governor of the Bank of Israel believes the new government in 2013 will have to raise taxes; the Minister of Finance disagrees.
Israel’s foreign exchange reserves fell in November despite a revaluation of the shekel that increased reserves by $64 million. In Q3 2012 Israel had a current account surplus of $800 million vs a deficit of $600 million in Q2 and a $1.3 billion deficit in Q1. This was the result of reduction of deficits in the primary income and goods accounts. Export of goods and services totaled $22.6 billion in Q3 while imports of goods and services totaled $22.2 billion. There was a 2% sequential drop in exports. Traders and analysts expect the shekel to continue to strengthen. It is also our opinion that shekel expectations are being influenced by the shift in the current account and by expected future shifts resulting from the emerging natural gas industry.
Positive sector-driven, geopolitical, and macroeconomic developments, along with our technical analysis view of the global Israeli equity market, lead us to remain bullish on global Israeli equities in the medium-long term. We see a positive risk-reward relationship despite the ever-present geopolitical currents in the Middle East.
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 economic 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.
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.