Josh Kaplan & Steven Schoenfeld: BlueStar Israel Equity Market Outlook–Mar. 2013 in Review & Apr. 2013 Outlook
By Josh Kaplan and Steven Schoenfeld of BlueStar Global Investors LLC-–April 8, 2013
This monthly column produced by BlueStar Global Investors discusses Israeli equities traded worldwide. The benchmark for our review is the BlueStar Israel Global Index TM (“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 aims to help 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 TM (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 exclusively on exchanges outside of Israel – including NYSE, Nasdaq, and the LSE – thus providing investors with a benchmark that is balanced across key sectors. (For example, BIGI has a 31% tech weighting, while MSCI Israel has only a 13.5% tech weighting). In addition, BIGI limits the largest constituent member to a weight of 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.
Imminent Breakout or Short-Term Peak? (April 5, 2013)
In March, Israeli Global Equities, as measured by the BlueStar Israel Global Index TM(“BIGI”), built upon February’s solid performance with another strong month, gaining 2.49% in the month for a gain of 7.61% for the first quarter of 2013. In early March, BIGI recovered from a late-February sell-off then consolidated just below 18-month highs. We continue to be bullish on Israeli Global Equities in the medium and long terms based on fundamental, technical, and macro-economic factors.
As always, there is a dynamic mix of positive and negative factors influencing Israeli Global Equities, which we discuss in greater detail on the following pages. Broadly speaking, tailwinds include the recent positive economic indicators pointing towards economic expansion; the stability of Israel’s private and public financial sectors; the slight abatement of some geopolitical concerns; a strong local currency; the anticipated macro-economic effects of Israel’s emerging natural gas industry (which we believe is tied closely to the strength of the Shekel); as well as the diversification of Israel’s export markets and the ability of Israeli policy makers to deal with economic threats from Europe. We have also been encouraged to see positive flows into Israeli mutual funds over the past few months. Finally, as the new Israeli government took office in mid-March, we gained greater visibility into the future fiscal and economic management of the country and are confident that most of the key elements of success of the past government will remain in place
In contrast, headwinds continue to include regulatory risks in local industries, markets, and tax policy; a deepening of Europe’s economic and financial woes; as well as certain omnipresent geopolitical risks. Another potential negative factor that could impact the equity market is insider selling or divestment by Israeli holding companies and/or their dominant individual shareholders, which would be partly tied to economic policy and partly tied to rising equity prices. Overall, economic activity in Israel, the United States, and other important global markets has been on the rise, albeit at a slower-than-optimal pace, and points to further expansion. However, the aforementioned risks pose serious threats to the seven-month recovery in Israeli equities. The most imminent risk to Israeli Global Equities is further deterioration in Europe’s situation, which could lead to slower export growth via an even stronger shekel or weaker demand, or cloud visibility in one of Israel’s largest export markets. Geopolitical risks are predominantly focused on the Syrian civil war spilling over into both the Golan Heights and Lebanon, but it seems that these risks will not affect the local economy in the immediate future. As an example of this mixed picture, in early April, there was an exchange of fire between Israel and Gaza and we learned that Iran would possibly slow its pursuit of nuclear arms capabilities until later in the summer.
A majority of economists/strategists believe that Israel’s GDP will grow at or above a 3.2% rate in 2013 but, if not for the commencement of domestic natural gas deliveries, the economy would grow around 2.2%. Additionally, it is widely accepted that global economic activity in 2013 will be back-end loaded. Thus, we are watching closely for signs that projections on Israel’s 2013 GDP growth too harshly discounted the net export segment of GDP and that Israeli GDP growth (ex-natural gas revenue) could surprise to the upside this year. Additionally, as Israel’s population grows and housing prices continue to rise (despite demand-side policies aimed at slowing the rise in housing prices), supply will have to ratchet up in the near future leading to another source of potential economic activity.
Israeli Global Equities — as measured by BIGI TM – underperformed U.S. equities but outperformed other developed and emerging market equity benchmarks in March. The past nine months or so have witnessed the greatest performance differential between Israeli Global Equities and other equity benchmarks, especially the S&P 500, in several years. This played out against a backdrop of better-than-OECD-average GDP growth and one of the most stable banking sectors in the world. Thus, we attribute last year’s underperformance to overblown fears of geopolitical tumult. As we have seen repeatedly over the past 35 years, when fear-based selling of Israeli Global Equities subsides, long-term investors are rewarded with strong outperformance.
BIGI (BlueStar Israel Global Index TM) Performance Versus the TA-100 and S&P 500 Indices since January 2010
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.
March 2013 Sector Performance and Winners and Losers
Israeli Health Care stocks were the best performers in March, leading Israeli Global Equities for the second consecutive month. Israel is home to world-renowned Health Care companies including pharmaceutical, biotechnology, and medical equipment companies and they are among the highest-weighted Israeli Global Equities by market capitalization. In March, we learned that exports of pharmaceutical products from January through February 2013 were 43% higher than they were from November through December 2012. Teva, Perrigo, Kamada, and Taro Pharmaceuticals contributed the most to the rise in the Health Care sector in March, gaining 5.4%, 5.0%, 7.2%, and 2.1% respectively. Kamada posted its first quarterly net profit as revenue rose 22% over 2011. Kamada will publish 2013 guidance in April. Teva reported that it will redeem $500 million of bonds due in 2016, using cash-on-hand for the redemption; an oral alternative to Copaxone, one of Teva’s most important products, that was developed by a competitor to Teva was cleared by the F.D.A. for marketing in the U.S.; Teva won FDA approval to market an oral contraceptive in the U.S; and the pharmaceutical giant will divest some of its holdings/joint ventures in Clal Biotech as part of its new strategy to deliver sustainable returns to shareholders.
The Financials have been among the top three performing sectors over the past eight months. Aside from increased mortgage activity, rising home prices, and rising equity prices, the Israeli banking system has been able to limit its exposure to the European financial crisis with minimal exposure to Cypriot and PIIGS’ sovereign debt. The major Israeli banks’ capital adequacy ratios are above what is required by the Ministry of Finance and their stability has been the bedrock of the Israeli economy and equity market recovery over the past several quarters. The banks and other financial companies are still exposed to regulatory risks, however. As the new government takes over, Israel’s leaders will continue to seek ways to increase competition in the financial and non-financial markets there. In March, the Bank of Israel adopted recommendations for increasing competition in the banking industry which it hopes will reduce the cost of banking services for small businesses and households, increase the total available credit, and increase the quality of service.
Bank Hapoalim and Bank Leumi both reported earnings this month. While maintaining its position as Israel’s largest bank, Bank Hapoalim’s profits were down 7.4% in 2012. Bank Leumi’s fourth quarter profit was down after it set aside NIS 400 million for a fine in a U.S. tax authority probe and NIS 323 million for streamlining measures. Several of Israel’s largest banks undertook cost-saving measures during the second half of 2012 in order to increase operational efficiency and work toward more sustainable profitability going forward, leading to the recovery in Israeli financial stocks followed by a recovery in the rest of Global Israeli Equities. Shlomo Eliahu sold NIS 300 million worth of Bank Leumi Shares in March; Eyal Ofer sold 2.2% in Mizrahi Tefahot shares while retaining control of the bank.
The Oil & Gas sector continues to be a leader within Israeli Global Equities. This industry is still in its infancy but is maturing quickly. The first deliveries of natural gas from the Tamar reservoir arrived in Israel as of the first of April. For several quarters we have promoted an overweight in the Oil & Gas sector, especially beginning in December 2012, when GDP projections for 2013 began to emerge. Projections for Israel’s 3.8% growth were said to sound better than they actually are because one-third of that growth would come from the Oil & Gas sector.
At that time, we stated the following: “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. It is certainly not expected that this group of stocks will rise in a straight line. There will be times when the group is over-valued or when certain risks are not discounted fully, but we are viewing this sector as a long-term buy-and-hold investment.
The positive impact on Israel’s economy of the natural gas reserves is already being felt – the market believes that, in the coming months, electricity rates will either be reduced or rise much less than they have in recent months. Also, gasoline prices are dropping as a side effect of the first natural gas deliveries. In addition to reducing inflationary pressures in the economy and eventually creating jobs, energy independence will cause a dramatic, positive shift in Israel’s Balance of Payments, making Israel a wealthier and even more credit-worthy nation on the whole.
Oil & Gas sector highlights in March include:
- Noble Energy raised the Leviathan reservoir’s natural gas estimate from 17 to 18 trillion cubic feet
- Valuable gas condensate, potentially worth $3 billion, was found in the Leviathan and Tamar fields
- Leviathan partners are at risk of being labeled a cartel, making the sale of 30% of their rights to Australia’s Woodside Energy a bit more complicated
- Gasoline prices fell 5% on April 1
- Gas from the Tamar site flowed 185 kilometers to come onshore at Ashdod on April 1
- Prime Minister Netanyahu called Turkish Prime Minister Erdogan to apologize for the loss of life and any mistakes made by the IDF/IAF during a raid on a Gaza-bound Flotilla in 2010 — this led to confirmation of recently emerged rumors that Israel will be able to supply Turkey with natural gas for both domestic consumption and for sale elsewhere
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 the sharp drop at the beginning of Operation Pillar of Defense), the BlueStar Israel Global Index (BIGI) consolidated in December and resumed its upward movement in January and February. The market selloff during Operation Pillar of Defense to the 200 index level for BIGI confirmed that this is a significant medium and long term level of support for the index. We think that BIGI’s price action during February and March may have been part of a mini bullish cup-and-handle technical formation with the area near the key level of 230 (depicted by the solid green line on the three-year chart below) as the handle. The 230 level coincides with a “soft” resistance area dating back to late 2011. BIGI took out that level in February, pulled back to 225, which is the bottom area of the “cup,” before recovering, and ended March back above 230 near the 235 level.
At this point, we are looking for further confirmation that the 230 level has transformed from a key resistance level to a new point of support. We are also looking for a more decisive break-out above the upper band of the upward channel depicted in the three-year chart below, currently at 233/235. If BIGI TM cannot hold above this level/above the channel, we suspect that the index could pull back to the 220 level, which is a secondary level of support coinciding with the bottom band of the aforementioned channel. At that level, or upon confirmation of 230 as the new level of support, we would look to buy Israeli Global Equities more aggressively.
The longer-term outlook for Israeli equities continues to be firmly bullish as the index has re-entered the channel connecting the 2008/2009 lows, as illustrated in the BIGI TM six-year chart (below), which spans the entire 2008-2009 global financial crisis. The longer-term outlook will become even more bullish if Israeli Global Equities decisively breaks through the above-mentioned upper band of this channel which has crept up above the 235 level. At February’s highs, BIGI did in fact break through the upper band of the channel before pulling sharply back into the channel. In March, the Index continued to rise as it hugged the upper band of the channel. If this breakout 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 6-year chart below) and a consolidation at the 2011 high of 275.
Risk management parameters for those with a shorter time horizon have not changed since February and should include a stop-loss activated with a daily close below the lower band of the upward channel which, for now, coincides with the former 220 resistance level, and a “hard” stop-loss with a weekly close below the 200 level. 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 maintain our medium and long-term targets as high as the 275 and 300 levels, respectively.
The key elements of the fundamental outlook for Global Israeli Equities are the following: foreign investment flows and liquidity on the Tel Aviv Stock Exchange; geopolitical events; regulatory risks aimed at increasing competition in the broader economy; and the possibility of a rise in insider selling or divestment among Israel’s infamous corporate pyramids. Last month, the Tel Aviv Stock Exchange voted to extend its trading hours to 5:30 p.m. Israeli time – effective mid-April – with the hope that the extended trading hours would lead to higher volumes on the Tel Aviv Stock Exchange as more trading hours per day would overlap with markets in different time zones around the world. Market participants are also hoping that Israel will eventually be included in a regional benchmark index, such as MSCI’s or FTSE’s Europe Index, thus forcing regional portfolio managers to include Israel in their investment universe and bring more investment to Tel Aviv-listed shares.
The flow of assets into Israeli mutual funds was strong in March. In the first week of March alone, mutual funds raised NIS 2.3 billion in assets, which was 125% higher than the assets raised in the last week of February. In the second week of March, assets continued flowing into Israeli funds but at a slower pace.
President Obama visited Israel in March. During his visit he made several speeches giving Israelis a sense of reassurance that the U.S. will not allow Israel to face its enemies alone. This reassurance from Obama seemed to affect participants in the financial markets as Israeli Global Equities rose throughout March and after the President’s speeches. The main geopolitical event of the month, though, was an unexpected call by Prime Minister Netanyahu to Prime Minister Erdogan of Turkey in which the Israeli leader apologized for possible miscalculations which lead to the death of Turkish activists on a Gaza-bound flotilla back in 2010. This apology led immediately to the announcement that the two former allies would return to normalized relations – although Turkey has since been partly backtracking on their commitments. The impact is multifaceted: bilateral trade and travel can work its way back to normalcy; the two nations can cooperate on military exercises and intelligence sharing as they used to and resume the trade of military systems and equipment; and most notably, the two nations will be able to cooperate on exploring arrangements to sell Israeli natural gas to Turkey, whose domestic gas consumption is expected to grow along with its economy over the next decade.
The civil war in Syria has spilled over in several isolated instances into both Israel and Lebanon. There does not seem to be an immediate wide-scale threat to Israel in the North but the situation is worrisome. In regards to investing in Global Israeli Equities, we keep a watchful eye on developments but defer making decisions based on geopolitical risks until the situation devolves to the point that military confrontation seems imminent. Also in late March and early April, rockets were fired from Gaza into Southern Israel for the first time since the November 2012 truce. Israel responded to these attacks with a targeted airstrike in Northern Gaza. Finally, several reports in early April point to Iran halting uranium enrichment until after its mid-summer presidential elections, although few expect Iran to become more flexible in their on-again/off-again negotiations with the P5+1 talks, most recently held in Kazakhstan.
Economic and Fiscal Outlook
In March, the Israeli purchasing manager’s index neared the expansion level, and key areas of the economy– the export demand and the employment components of the index–were firmly above the expansion level. One of the major undercurrents in Israel’s economy and a contributor to dollar-denominated returns in Israel’s equity markets is the unrelenting appreciation of the Israeli Shekel. In the beginning of March, several banks and financial firms were – as reported by Globes – calling for a reversal in the strengthening of the Shekel, stating that the Israeli economy is “screeching to a halt” and that a correction or reversal was not only due but warranted. Later in March, these same firms changed their tone a bit stating that the Shekel will continue to strengthen until the Bank of Israel interferes directly in the foreign exchange markets. Some reasons for Shekel strength included higher interest rate differentials between Israel and global markets as well as the fiscal stability of the Israeli government. In addition, the expected effect of the natural gas industry on Israel’s Balance of Payments picture is likely putting upward pressure on the currency while adding to expected future fiscal stability of the government. We also believe that at some point the Bank of Israel must sell shekels in order to maintain the momentum of Israel’s expanding economy and soon-to-be-booming natural gas export industry.
The real estate market in Israel continued to heat up in March; new mortgages were up by 20% during the month and real estate prices have risen so much over the past several years that mortgage payments now account for nearly 41% of Israelis’ average monthly salary. It is widely accepted that the real estate issues are predominantly supply driven. Construction companies will have to continue increasing the supply of housing in Israel which would have two positive side effects: First, easing the rise in housing prices and second, increasing economic activity in the construction sector further.
The last major event in March was the formation of a new Israeli government. The new Finance Minister – Yair Lapid – has vowed to crack down on government spending and tax collection. Furthermore, the newly-minted minister – who has never held public office and has minimal economic or finance experience – announced that he will reduce tax breaks for companies in central Israel under the Law for Encouragement of Capital Investment. However, despite the potential risk of Finance Minister Lapid’s inexperience, Prime Minister Netanyahu has made it clear to the markets that the newly formed government will make fiscal responsibility and increased competition in Israel’s markets the centerpiece of its economic policy; perhaps Israel’s fiscal policy should serve as a model for the rest of the developed world to follow…
Overall, we remain bullish on Israeli Global Equities in the medium and long terms. We will not be discouraged if we see Israeli Global Equities consolidating in April and won’t be surprised to see this continue into the middle of the second quarter of 2013. However, we believe the upside potential from these levels far outweigh the downside risks, and retaining or opportunistically adding to an Israeli equity overweight during any pullbacks would be a prudent approach to the current environment.
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. 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 – www.ActiveIndexInvesting.com ). Josh Kaplan is a Research Associate at BlueStar Global Investors LLC, and a Contributor to IsraelStrategist.com