The author is a senior vice president and head of trading, indexes and derivatives at the Tel Aviv Stock Exchange. The conclusions and opinions expressed in this article are the views of the author only. Nothing stated in the article should be regarded as a recommendation or advice to act in any way, including in relation to investment decisions, and it is no substitute for personal investment advice that takes into account the needs and situation of each individual.
So far this year, the S&P 500 Index has climbed 7.7%. The index, the leading benchmark index of the US stock market, has risen by 11.2% in the past three months. In 2022 as a whole it fell 19.4%.
The Tel Aviv 125 Index, the leading benchmark index for the local stock market, has risen 2% so far this year. In the past three months, it has fallen 4%, and in 2022 as a whole it fell 11.8%.
The gap in performance invites comparison between the pricing of securities over the past three months between these two indices, which represent the backbone of the equities component in Israelis’ investment portfolios.
On the basis of 2022 results, the p/e ratio of the companies in the S&P 500 Index is 19, while analysts predict minor growth, of 3%, in annual profits in 2023 in comparison with last year.
According to Bloomberg, the p/e ratio of the companies in the Tel Aviv 125 Index is currently just 10.7. These are extreme pricing gaps, and they have widened considerably in recent weeks, as the Tel Aviv Stock Exchange fell while the US stock market rose sharply.
The gaps look even more extreme if we take into account that the Bank of Israel’s interest rate is 1% lower than that of the US Federal Reserve, and that the dividend yield on the Tel Aviv 125 is 70% higher than the yield on the S&P 500, which is 1.63%.
The technology sector has the highest weighting on the S&P 500, amounting to 26.8%. It would be appropriate to add to that the telecommunications services sector, which has a 7.83% weighting, to give an aggregate weighting of 34.6%. The p/e ratio of the technology sector in the US is 23.5, while for the telecommunications sector it is 17.2. These are the two sectors most vulnerable to a slowdown in economic growth and to high interest rates. Investors in the US, however, who unloaded technology stocks almost indiscriminately in 2022, have decided that this is the time to increase exposure to these sectors, which have accordingly shot up by 14% and 21% respectively in 2023 to date.
The weighting of the technology sector in the Tel Aviv 125 is 26.7%, 7.9% short of the weighting in the S&P 500. This figure is one of the main reasons for the under-performance of the Tel Aviv 125 in recent months, just as it contributed to the Tel Aviv 125 outperforming the S&P 500 in 2022.
The Tel Aviv Technology Index has responded to the positive global trend in the sector, and has climbed 9.5% so far this year. This is not as good as the performance of the technology sector in the US, but the performance of the technology sector within the Tel Aviv 125 is 7% better than the performance of the index as whole. Last year, the technology component of the local index fell 26.7%, while the technology and telecommunications sectors in the US lost 27.6% and 38.7% respectively.
So although Israel’s technology industry is attracting a great deal of attention in the current political situation, investors in local stocks in the sector, which are mostly dual-listed, have reacted consistently to global trends, and less so to the prophecies of economic doom.
Banking sector prices fairly
Another sector that looms large in the performance gap between the Israeli and the US markets is banking, which has flourished in recent years. The p/e ratio of the finance sector in the US is 13, and the sector’s weighting in the S&P 500 Index is 11.7%. The US banking sector has climbed 8.9% so far this year, and it should be noted that about 78% of its revenue depends on the US economy.
The weighted p/e ratio of the local banking sector is just 7.3, after a peak year for profits. The sector’s weighting in the Tel Aviv 125 Index is 19.7%, which is 70% more than the weighting in the S&P 500. After 2022, which as mentioned was a peak year for profits, as the economy grew rapidly, interest rates rose sharply but were only slowly and partially raised for customer deposits, and debt loss provisions were very low, and even given a significant rise in provisions in the forecast slowdown in economic growth and a narrower interest rate spread, the pricing of the banking sector still seems fair.
It can be presumed that the concern that local banking executives have expressed for the banks’ stability and the fear of money exiting the banking system and going overseas are reinforcing the pessimism of investors about the sector’s performance and weighing on the Tel Aviv 125 Index. In my view, talk like this, which Is not just the preserve of the heads of the banks, is dangerous, and every statement on the matter must be seriously and carefully considered, because sometimes statements themselves create the reality.
It is worth saying that the macro environment forecast for the US in 2023 is expected to be much less comfortable than what is forecast for Israel, according to the best analysts in Israel and overseas. While Israel is expected to have annual GDP growth of 2-3%, inflation of 2-3%, and a fiscal deficit of 3% of GDP, in the US the forecast for annual growth is 1-1.5%, the rate of inflation is expected to be 3-4%, and the fiscal deficit is expected to be 5% of GDP.
The banking system in any country is an excellent barometer of its current and future financial strength, and there is therefore a growing feeling that the pessimism about the judicial reform issue is depressing investment managers’ decisions, in a way that is divorced from the forecast economic numbers.
Standard deviation lower in Tel Aviv than in the US
Examination of the 30-day average standard deviation of the Tel Aviv 125 Index in comparison with the S&P 500 Index shows that even after the recent rise in volatility of the local index, the local standard deviation is still lower by about 0.5% than the US equivalent. Taking a longer view, of the standard deviations of these indices over the past five years, which many see as reflecting the degree of risk in the market, the local standard deviation is lower than that in the US.
That being the case, the comparison between the p/e ratios of the Israeli and US markets, with the aim of understanding the performance gaps between the performance gaps between these two markets in the past three months, in the light of current and forecast profits, alongside analysis of the macro forecasts by the best analysts, lead to the conclusion that the Israeli market is considerably more attractive at this time than the US alternative.
Published by Globes, Israel business news - en.globes.co.il - on February 8, 2023.
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