Josh Kaplan & Steven Schoenfeld: BlueStar Israel Equity Market Outlook–Jan. 2013 in Review & Feb. 2013 Outlook
By Josh Kaplan and Steven Schoenfeld of BlueStar Global Investors LLC-–February 14, 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. Yet few are aware of the global footprint of Israel’s companies in other sectors, and fewer still know 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 1500% 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 limits 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.
Onward and Upward (Written on February 4, 2013)
Israeli Global Equities continued their upward march in January. The initial trading days of 2013 were strong for stocks across the globe. Israeli Global Equities traded in a narrow range following the opening days of the New Year, and finished the month at the upper end of this range. Israeli Global Equities have since (in the first few days of February) broken out above this range. Equity markets worldwide benefited from the reduction of risk associated with the U.S.’s fiscal situation. Additionally a generally positive start to the current earnings season, both in U.S. and Israel, helped bolster investor confidence that the positive sentiment towards equities as an asset class is not solely based on monetary easing.
In January, Israeli investors continued adding to their mutual fund holdings and the Israeli corporate debt market seemed to start loosening up. The Israeli Government also held an auction for dollar-denominated 10- and 30-year government bonds in New York. The offering was oversubscribed and the government was able to sell dollar-denominated bonds at its lowest rate ever. This, along with Israel’s higher-than-OECD-average expected GDP growth, is the most telling sign we have seen in a while that Israel’s economy offers both developed market stability and emerging market growth. The main risks in the Israeli equity market have shifted away from macro developments in Europe and the U.S. The most imminent risks are Israel’s own budgetary concerns, socio-economic reforms, and the chance of the Syrian civil war transforming into a regional problem. Some view the strength in the Shekel as a de facto negative factor for Israel’s economy; we view it as a double edged sword.
BIGI (BlueStar Israel Global Index) Performance Versus the TA-100 and S&P 500 Indices Since Jan 1 2010
Israeli Global Equities, as measured by the BlueStar Israel Global Index (BLS:IND), were up 2.38% in January after a flat December. The BlueStar Israel Global Index performed more in line with global equity markets than the other Israel equity indexes. The BlueStar Israel Global Index outpaced the TA-100 and MSCI Israel by a wide margin for the second month in a row.
This month’s Israel equity benchmark performance differentials are particularly interesting. Israeli Global Equities outperformed emerging market equities yet underperformed developed market equities, while “domestic” Israeli equities underperformed developed market equities and were generally in line with emerging market equities. We attribute this to the leadership in the technology sector. Nearly 20% of Israeli technology companies are included in the BlueStar Israel Global Index yet excluded from other Israel equity indexes. We continue to hold the view that Israel Global Equities will play catch up to other developed market equities in 2013. We remain bullish on the Israeli Global Equity market based on fundamental, technical, and macro-level assessments, though the year will not be without its speed bumps.
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.
January 2013 Sector Performance and Winners and Losers
After leading the BlueStar Israel Global Index’s rebound for several months, the Financials took a break in January. Though the domestic oriented sectors like Financials, Consumer Services, and Oil & Gas led and provided stability to Israeli Global Equities throughout the turbulence of global macro headwinds and geopolitical events in the later part of 2012, Israel’s global Technology companies and export-oriented sectors have taken the lead.
The best performing Israeli technology companies in January were Electronics for Imaging (EFII: NASDAQ; up 19.12%), Verifone Systems (PAY:NYSE; up 16.98%), Babylon (BBYL:TASE; up 15.98%), Verint Systems (VRNT:NASDAQ; up 15.12%), DSP Group (DSPG:NASDAQ; up 13.89%), and Comverse Technology (CMVT:NASDAQ; up 13.54%). Technology stocks are generally cyclical and span across many subsectors. The fact that the rise in technology companies was broad-based shows that global growth in discretionary spending, capital expenditure on upgrading technology, and innovations in product pipelines are expected to rise and that global economic growth could surprise on the upside in 2013. This is particularly encouraging for Israel’s economy and equities because this is the country’s sweet spot as far as exports are concerned; technology, bio-tech, and pharmaceutical exports have been a cornerstone of Israel’s superior growth over the past two decades.
Some analysts have predicted that the strengthening of the shekel, which is expected to continue, will stomp out the prospective recovery in Israel’s technology sector. Though this argument is the conventional wisdom on how currency fluctuations affect imports and exports, there are two counter points we’d like to make. First, many of Israel’s technology production facilities are located outside of Israel and their inputs, selling prices, and balance sheets are not necessarily denominated in Shekels; the relationship between the shekel and technology exports is a bit ambiguous for the sector as a whole and should be examined on a company-by-company basis. Second, currency fluctuations will have the strongest effect on products that can be closely or perfectly substituted for one another or, put another way, commoditized. Technology is a bit different because many, certainly not all, technologies are not quite perfectly substitutable. The potential for obsolescence exists but this is a risk separate from currency fluctuations.
The aggressive pricing/packaging competition in the Telecommunications industry is continuing to be a drag on the major telecom service providers. The biggest players have responded by offering all-in-one service packages and reduced rates, and streamlined operations. Though this pricing war is “old news,” there are two exciting prospects for the space, led by the government. First is the prospect of allocating 4G frequencies throughout the country. Second is that the Ministry of Finance signed a permit to allow Israel Electric Corp to engage in the telecommunications industry. This is viewed as the government’s final step in its plan to create a fiber optic network across the nation. The network will cost NIS 5 billion and will be financed by both IEC and a group of investors. Deployment is set to begin in late 2013 and could be an added boost to 2013 GDP. Companies involved include Rapac Communications, BATM Advanced Communications, and Bynet Data Communications.
Koor Industries and Israel Chemicals led Israeli Basic Materials stocks higher. Koor Industries is a holding company and derives a portion of its income from the materials company Makhteshim Agan. However, Koor Industries rose in January on the back of its investment in Credit Suisse, which rose 22% in January and 70% over the past six months. Israel Chemicals signed a $264 million deal to supply China with 600,000 tons of potash through June 2013. Also, Canada’s Potash Corp. is continuing to pursue a controlling stake or outright acquisition of the Israeli minerals and chemical giant.
The Oil & Gas sector continues to lead Israeli Global Equities. This sector’s development will have transformative and stabilizing effects on all facets of Israel’s economy, either in the short or long run, from government borrowing costs to discretionary spending and individual/firm level budget constraints, to unemployment, to balance of payments and geopolitical dynamics.
Our views from last month’s outlook continue to reflect our views on investing in this sector, against the backdrop of expectations that Israel’s GDP growth in 2013, excluding Oil & Gas– related growth, will be disappointing: “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 [outside the oil & gas sector].” Additionally, though this sector currently holds a small weight in the BlueStar Israel Global Index, the weight will grow over the years and decades to come; overweighting smaller growth sectors, we believe, is a prudent long term investment strategy.
Other Oil & Gas sector headlines in January included:
- Signs of substantial amounts of gas were found at the Aphrodite 2 well in the Ishai license
- UBS raised Tamar and Leviathan partners’ valuations and prices
- The Prime Minister’s cabinet approved a switch from oil to gas for public transportation
- Modiin Energy will begin drilling the Gabriella site in the first half of 2013
- LNG imports began to deliver gas to 8 IEC power stations and other gas companies
- Israel Opportunity is in talks to buy a stake in Gabriella from Modiin Energy
- A group of Israeli investors will acquire 90% of Geo Global Resources, the first deepwater drill operator to be owned by Israelis
- Shemen Oil and Gas Resources increased the expected cost of developing the Yam 2 offshore oil well
- IEC may lease a second LNG tanker to import gas to meet Israel’s growing energy needs until gas from Tamar arrives
Profiles of Key Company Movers in January
Delek US Holdings (DK:NYSE) gained 34% in January after breaking out from a 6-month long consolidation near the $26/share level. Delek US is an integrated energy business operating in the Midwest and Southern regions of the U.S. In addition to benefiting from lower input costs, Delek announced it is going to purchase EQM Technologies & Energy’s biodiesel production business. Delek’s core business is still refining petroleum. However, the company has transformed itself into an integrated oil and gas company with its acquisition of Lion’s, and it continued to diversify and insulate its earnings from oil price fluctuations with the biodiesel acquisition. We believe its stock price rise is driven by both its earnings growth prospects as well as expected reduction in earnings volatility.
Electronics For Imaging (EFII:NASDAQ) made a vertical move upward in January, and after a brief consolidation in early February, seems to be on the move again. The stock gained 19% in January 2013. Electronics For Imaging provides digital print controllers, industrial super-wide, wide format and label and packaging digital inkjet printers that use digital ink, and business process automation solutions. In January and early February, the company announced a patent litigation victory, that its products will be used in a new line of Xerox color printers and presses, and that it beat its Q4 2012 earnings estimates by $0.06 or 16%.
Cesar Stone Sdot Yam (CSTE:NASDAQ) gained 17.5% in January and has gained nearly 7% more in the first days of February. CesarStone is involved in manufacturing synthetic quartz surfaces sold in 42 countries around the world. Its products are used primarily in kitchen countertops, wall panels, backsplashes, floor tiles, stairs and other interior surfaces in residential and commercial buildings. The company’s shares rose strongly in January on improved housing fundamentals in the U.S. The company announced earnings on February 6th which surpassed expectations as the management increased guidance. This was not a case of “buy the rumor sell the news” as the stock jumped by 7.5% on the earnings report even after a strong January. With a P:E of 16 (at the time this column was written), the stock is not very cheap, but there has certainly been a less reasonable trading multiple before.
Market Trends – Technical Analysis and Market Fundamentals
Technical Analysis of the Israeli Market
After breaking important trend lines in November (during Israeli Global Equities’ rebound from Operation Pillar of Defense), the BlueStar Israel Global Index consolidated in December and resumed its upward movement in January and early February. The market selloff during Operation pillar of defense to the 200 index level for the BlueStar Israel Global Index confirmed that this is a significant level of support for the index. The retreat to that level also coincided with a new uptrend line. The rebound in November from the 200 level sent Israeli Global Equities above the former resistance level of 220 represented by the dotted green line on the two-year chart below. In December, Israeli Global Equities fluctuated closely around this level and in January momentum carried Israeli Global Equities higher to the resistance level near 230, depicted by the solid green line on the two-year chart below.
The short-term outlook for Israeli Global Equities is solidly bullish, though there is always the chance that the Index will come back in to retest the 220 support level or the new uptrend line which is currently near the 210-212 index level. If there are no negative shocks, we expect the upward momentum to carry Israeli equities higher to resistance near the 230 level or above. If Israeli Global Equities make a decisive move above the 230-232 level, they will be making new 52-week highs and the next area of resistance is expected to be around the 245-250 level.
The longer-term outlook for Israeli equities is now firmly bullish as the index has re-entered the channel connecting the 2008/2009 lows, as illustrated in the BIGI five-year chart, which spans the entire 2008-2009 global financial crisis. The longer-term outlook will become even more bullish if Israeli Global Equities breaks through the upper band of this channel which is close to the short-term resistance level of 230, adding to the significance of a potential move above 230. If this occurs, we see the projected upside potential of the index to be at the 300 level by mid 2013, though most likely following a break at the resistance level of 245-250 (depicted by the solid green line on the 5-year chart below) and a consolidation at the 2011 high of 275.
From a risk management perspective, the stop-loss at the 195/197 level articulated in our last four Outlooks remains valid. For those with a shorter-term perspective, a breach below the former resistance/new support level of 220 should be viewed as a warning signal with a stop-loss level of 210-212 at the newly established uptrend line, which connects the mid-2012 low near 192 and the test of the 200 level during Operation Pillar of Defense in November. For the longer-term investor, 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 stop-loss levels have so far held, the close of BIGI decisively above the 220 level has confirmed that this major multi-year support level has held, and is most likely 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.
Israeli mutual funds raised a net NIS 7.5 billion in January 2013, an extension of the net rise in mutual fund assets which began in December 2012. In December, though, mutual funds raised a mere NIS 860 million. Overall bond and corporate bond funds were clear winners, raising nearly NIS 3.7 billion in January. Equity mutual funds focusing on investing in Israeli equities raised NIS 100 million, while equity funds specializing in foreign equities raised only NIS 22 million.
In the “Globes” Big Money Survey for 2013, all participants expected the TASE rally to continue through the year and one-quarter of participants expected an 18% rise. Over half of investment houses surveyed recommended oil & gas companies as their top picks for the year and the top stocks in this sector were Avner Oil & Gas, Isramco Negev II, and Ratio. Respondents also favored the financials stocks. Lastly, PwC says there were $5.5 billion in Israeli high-tech exits in 2012 and they expect 2013 to witness some very interesting IPOs and exceed 2012’s exit total.
Two months after Operation Pillar of Defense, there has been a lull in the tensions between Hamas in Gaza and Israel. As we saw during the conflict in Gaza, equities markets rebounded strongly after understanding the true risk of that military action. However, the risk of the Syrian civil war spilling over into the broader region, including Israel, is becoming more real. In January, the Israeli Air Force struck targets in Syria in an effort to contain Syrian WMDs and anti-aircraft defense systems and to prevent them from falling into the hands of Hezbollah. Iron dome batteries have been deployed strategically in the North, in Haifa and the Golan. Last month, there was a “mysterious” explosion in Iran’s second-largest nuclear material enrichment facility. A few days later reports came out that the U.S. has devised “sophisticated blueprints for a surgical operation” to set back Iran’s nuclear program if negotiations fail. Iran has signaled a willingness to return to the negotiating table recently while also making an historic visit to Egypt to meet with President Morsi.
The geopolitical risks in the Middle East are omnipresent and very fluid. The biggest geopolitical risk to Israeli equities is that of an indefinite or extended cold war or war of words. In this situation, investors could conjure up dire situations or discount perceived risks at an unwarranted degree. We saw this during mid-2012 when Iran and Israel exchanged threats on a weekly basis. These exchanges weighed on the TASE more heavily and for a more extended period of time than the actual military conflict in Gaza did in November 2012.
Economic and Fiscal Outlook
GDP expectations for 2013 are still quite mixed, ranging from 2.8% to 3.9%. Many analysts and officials are unsure of how to include natural gas production into GDP growth. The OECD expects Israeli GDP growth to be 3.6% in 2013, the highest of Western Developed economies and nearly 1% higher than the OECD average. Though GDP expectations are mixed, there is a broad consensus that Israel’s natural gas production and development will contribute to nearly 1% of GDP growth. Analysts say that investors should not take this 1% into account as the natural gas industry, at this stage, will not have a meaningful impact on unemployment or the government budget. Also, in December, manufacturing activity contracted for the 7th straight month: the purchasing manager’s index rose, but was still below the 50-point mark between expansion and contraction.
The Bank of Israel monetary committee announced it would leave its policy interest rate unchanged at 1.75%. The committee cited an inflationary environment which signaled a slow-down in domestic demand, declining exports, stability in GDP growth, and continued monetary easing by major central banks around the world. Also, as a reason for not yet raising interest rates, the Bank of Israel cited a World Bank analysis stating that commodity prices would drop in the next two years. Also, the committee reaffirmed its call for 3% GDP growth in 2013; it said that many indicators show that there will not be a further reduction in economic activity and that there are improved expectations about the government’s fiscal situation and ability to implement prudent economic policies. Many analysts expect the Bank of Israel to begin raising rates by the end of the year.
Foreign exchange reserves rose by $991 million to $75.86 billion at the end of December 2012. Israel’s trade deficit ballooned in 2012 by 142% to NIS 70.2 billion due to stagnation in exports and a 27% increase in fuel imports. The Shekel continued to strengthen throughout January and closed the month at NIS 3.714/$ and has strengthened further to NIS 3.682/ $ in the opening days of February. A unit of Alpha Platinum, as reported in a January 15th “Globes” article, stated that the Shekel has strengthened by 4.3% since October 2012 and has reduced the competitiveness of Israelis against the backdrop of an already difficult export market. They expect the Bank of Israel to reduce rates once more in 2013 to 1.5%. Israel’s trade deficit rose by over 140% in 2012.
A main economic concern for Israel is the growing budget deficit to GDP ratio; the 2012 budget deficit was 4.2% of GDP, or NIS 39 billion, which is double the projection at the beginning of the year. As part of the government’s plan to cut spending it intends to cut salaries and perks of public sector employees. The government also plans to cut the tax exemption on advanced study funds. Together these cuts could save the government NIS 3.4 billion. Further plans to cut spending and the potential of tax increases threaten to set back Israeli economic growth or Israeli equities in the coming months.
On a very positive note, the Israeli government raised $2 billion dollars in a 10 and 30 year bond auction in New York towards the end of January. The $1.5 billion dollar-denominated bond offering was oversubscribed by nearly $8 billion, so the government decided to issue an additional $500 million in 30 year debt. The bonds were sold at the lowest cost Israel has ever paid in a dollar-denominated issuance: $1 billion of 10 year bonds at 3.213%, which is 125 basis points above the U.S. government 10-year bond yield, and $1 billion of 30 year bonds at 4.588% which is 145 basis points above the U.S. government 30 year bonds yield.
Finance Minister Yuval Steinitz said: “This is a vote of confidence in the Israeli economy. The fact that we succeeded in continuing to reduce the debt-GDP ratio in recent years, and apparently last year too, created investor confidence in the soundness of the Israeli economy. The achievement is especially noteworthy in the view of the ongoing debt crisis in Europe.” We too believe it is an extremely significant indicator that investors from around the world—including from the U.S., UK, Germany, China, France, and Switzerland—expect that the Israeli government tax revenues will be increasing in the future and that the shekel will be strong. Investors may have considered in their risk analysis the effects of the natural gas industry (including lower energy input costs, lower public transportation costs, more tax revenue, or the yield from a sovereign wealth fund), tourism, or higher economic growth in general. This, we think, translates into a story for higher investor confidence in all of Israel’s markets in the longer term and reduction in overall risk in financial assets.
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.