Israeli markets price in qualified optimism

Tel Aviv Stock Exchange  credit: Eyal Izhar
Tel Aviv Stock Exchange credit: Eyal Izhar

For the time being, Israeli investors appear to prefer the uncertainty of war to the political uncertainty that it has replaced.

For years, the Israeli stock market has been correlated with US markets. When stocks rose in New York, so did stocks in Tel Aviv. That is, until this year. US stock indices have risen by double-digit percentages in 2023, but the Tel Aviv market has not benefitted from the recovery in the US, to say the least. While the S&P 500 Index has risen 15% in the year to date, and technology-heavy Nasdaq has soared 31%, the Tel Aviv 125 Index has fallen by 4%.

That is not the only link between the Israeli and US markets that has become uncoupled in recent months. The strength of the shekel against the US dollar has for many years been a function of movements on US stock markets, particularly Nasdaq. When Wall Street indices rose, the shekel strengthened, and when they fell, it weakened. This year, however, despite the surge on Nasdaq, the shekel has weakened against the US dollar by 8.7%.

Analysts are unanimous in saying that the main cause of these anomalies is the Israeli government’s judicial overhaul program and the opposition it aroused, which rocked the country for most of this year, despite the fact that Israel’s GDP, inflation, foreign trade, employment, and fiscal deficit numbers were better than those of most of the OECD countries.

Governor of the Bank of Israel Amir Yaron said in September, "There is no doubt that, since the beginning of this year, the shekel has become detached from the close link it had with overseas financial markets." He attributed the change to the judicial overhaul: "It (the shekel) reflects the growing uncertainty in the economy and the risk premium arising from the constitutional moves," he said, and put the consequent excess depreciation of the shekel at more than 10%.

With the outbreak of war on October 7, it might have been expected that the uncertainty, and investor pessimism about the Israeli economy, would only become worse. Indeed, for the first two weeks of the war, the Tel Aviv Stock Exchange fell, and the shekel weakened. The shekel-dollar exchange rate went above NIS 4/$, and the stock market fell day after day. But then came a turnaround.

On October 27, stock indices in Tel Aviv changed direction, and the pre-judicial overhaul correlation started to reassert itself. Since then, the S&P 500 Index has risen by 6.5%, and presented the strongest sequence of positive sessions since 2021, while the Tel Aviv 125 Index has risen by more than 7%. The trend is similar on the foreign exchange market. The shekel has appreciated against the US dollar by 5.7%, thus correcting the entire decline in the first two weeks of the war. Is this the start of a recovery in the local market? Why are the markets exhibiting what looks like optimism during a war?

First of all, we should explain the main mechanism behind the correlation seen between Tel Aviv and Wall Street in recent years. Israel’s financial institutions, which manage the Israeli public’s savings, have large holdings overseas - representing, in some cases, more than 50% of their assets. They hedge these investments in order to offset the risk of investing overseas.

Thus when stocks on Wall Street rise, raising the value of the institutions’ dollar-denominated assets, they sell dollars and buy shekels to offset their increased currency exposure, causing the shekel to appreciate. This year, because of the uncertainty surrounding the judicial overhaul, the institutions preferred to hold foreign currency, especially US dollars, and so the correlation unwound.

"A conflagration in the north could change the picture"

So what caused the change of the past two weeks? The war has led to greater social solidarity in Israel, and the judicial overhaul is, for the time being, a long way off the agenda, or at least that is how it appears. There is also optimism on security. On Friday a week ago, Hezbollah leader Hassan Nasrallah spoke publicly. The country, and the financial markets, feared that he would declare that Hezbollah was joining the fight against Israel, but the fears receded after his speech, which was interpreted as indicating an inclination to avoid all-out war on the Lebanese border.

The are also external reasons for the turnaround. The rally on Wall Street of the past two weeks has been buoyed by growing confidence on the capital market that the interest rate hikes by the US Federal Reserve are behind us. That is also the reason for the weakness of the US dollar against other major currencies. The labor market in the US is becoming less tight, and inflation there has been consistently moderating for several months.

Nevertheless, investment managers are cautious about declaring that the new-old trend is here to stay. "There is still uncertainty, and the link is still not unequivocal," says Eran Kalinsky, vice president of investments at More Investment House. "There is a sort of expectation that after the war, when it’s all over, and insofar as it ends successfully, the whole judicial overhaul idea will be dropped, the nation will be more united, the government will deal with more acute needs, the budget will be more growth generating, and the money will be invested in infrastructure development and in businesses that have been harmed, and less in political matters.

"There is thus optimism about the legislation issue, and so the local markets have become more correlated with what is happening on world markets. Nevertheless, there is still uncertainty on two planes. The first is that no-one knows what will happen politically, and the second is uncertainty about the war. If it remains on a single front and ends quickly and successfully, we will go back to a higher correlation with Wall Street."

Guy Mani, chief investment officer at Meitav Dash Investments, says, "It looks a bit like manic-depression. When the market fell sharply, the foreigners sold (shekels, R. W.), and now it looks as though everything is under control again and is back to what it was. But a conflagration in the north could change the picture once more, and so we shouldn’t become euphoric and think that the market is again looking at in the light of Wall Street."

Robert Carmeli, chief investment officer at Four Seasons Wealth Management of the IBI group, agrees that we may return to the correlation with Wall Street that characterized the shekel, if the war does not spread to additional sectors. "While the US market rises strongly, it’s likely that we will see the shekel appreciating, revealing the direct correlation between the two," he says. "The new equilibrium on the foreign exchange market is likely to be in the NIS 3.8-3.9/$ range, with volatility correlated with movements on overseas markets."

Do investors prefer security uncertainty to political uncertainty? Carmeli explains that investors in Israel have become used to the security risk. "Because of past experience with military campaigns and the capacity for recovery that Israel has demonstrated, the local market would at present prefer to cope with war, as long as it is contained, and limited to the southern front, a situation that we are very familiar with and have encountered many times in the past few years," he says. "Although this time it’s a more prolonged and deeper campaign than we are accustomed to, the economic consequences are starting to become clear, more or less, and as long as the situation remains as it is, the uncertainty will gradually be dispelled."

"In the long term Israel’s economy will strengthen"

Ultimately, the investment managers provide us with a little optimism. "If we’re on our way to an optimistic scenario both politically and with the war, then I expect not just a high correlation with the world, but outperformance by the Tel Aviv Stock Exchange, to make up for its significant under-performance since the beginning of the year," says More’s Kalinsky.

"Over time, in the long term, the Israeli economy will strengthen and grow more," Mani says. "Assuming that some of the security threats are removed, and the government leans towards switching money to growth-oriented sectors, amid demands for change in its priorities, some of the gap that we have seen in the past year between the Tel Aviv Stock Exchange and world stock markets will be closed."

Published by Globes, Israel business news - - on November 12, 2023.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2023.

Tel Aviv Stock Exchange  credit: Eyal Izhar
Tel Aviv Stock Exchange credit: Eyal Izhar
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