"Tel Aviv stocks are rightly cheap"

Yotav Costica  credit: More Mutual Funds
Yotav Costica credit: More Mutual Funds

Yotav Costica of More Investment House explains why the war has hit securities but not the shekel, and warns of the impact on future generations of Israel's expensive debt.

2024 opened with great optimism about the local securities market, despite the war. Experts from various financial institutions explained that the gap that had opened up between Tel Aviv and Wall Street would narrow, that stocks in Israel were priced low by global comparison, and that we were about to see a rally on the Tel Aviv Stock Exchange.

Almost half the year has gone by, however, and the gap is actually widening. The S&P 500 has returned 13% so far this year, and reached a new all-time peak last week. The Nasdaq 100 has jumped 15%, also to peak levels. And the Tel Aviv Stock Exchange? It’s lagging a long way behind, with a return of 1.3% on the Tel Aviv 125 Index.

Why is this happening? And where is the money exiting Israel going to? We talked to Yotav Costica, chief investment manager at More Mutual Funds, about the burning issues in the financial markets.

"Foreign investors are leaving Israel, that’s a fact. It can clearly be seen in the numbers," Costica says. "If we compare October, on the eve of the war, with the latest published numbers, for March 2024, we see a dramatic decline in holdings by foreign investors in bonds on the local market. Until October, they represented about 15% of total holdings of Israeli government bonds; today, they’re below 9%. That’s almost NIS 30 million that have exited."

Is the trend worsening?

"Yes. In March-April, the Israeli stock market performed fairly well. In May, we saw growing fears."

"Our children will pay for the county’s expensive debt"

Costica commented specifically on the government bond market, after the yield on ten-year bonds rose above 5% last week, for the first time since 2013. Yields have moderated slightly, but the value of Israel government debt is still historically low. "This has implications that should worry all of us," Costica said. "A country raising debt that it needs more than ever, at high interest rates. The consequence for the total budget cake is clear. Interest expense contributes nothing to my life, your life, the lives of all of us, and nothing to the services we receive from the state. There will be less money for education, health, culture, and the ones who will pay will be our children and the next generation."

There’s a large gap between the ratings that the international rating agencies award us and the situation in practice. Why is that?

"The three rating agencies currently rate us as belonging to the A family; all the ratings, incidentally, with negative outlooks, meaning that there is a likelihood that we will see a further downgrade within the next twelve months, but still, A is a very respectable place.

"In practice, we are rated A, but traded like countries with ratings of BB+, BBB-. This means that investors look at Israel and say ‘We don’t believe the rating agencies.’ In my personal view, this is going to an extreme, because in the end Israel is a strong country.

"In addition, in comparison with the past, the investment alternatives are very, very good, and so at the moment we are not as it were on foreign investors’ good side."

Do you see a situation in which Israeli financial institutions will bail out in favor of overseas alternatives?

"I can see that happening. The alternatives overseas are certainly interesting. The high interest rates are creating many opportunities. Bonds of strong countries like the US, and corporate bonds of high quality companies such as Microsoft and Meta and Google. In the end, the aim of a pension fund is to make the best return for the saver."

When you talk to foreign investors, what do you hear from them?

"There’s no definite answer. On the one hand, we are seeing clearly that foreign investors are reducing their holdings in stocks in Israel. Imagine you’re a German investor who is asking himself where to invest, would you want to invest in Ukraine? There are opportunities, but, let’s put it this way, there are alternatives. On the other hand, there’s the high-tech sector, where money is being raised, companies are making exits, and there are major funds operating here. Sequoia, for example, is opening a branch here. Insight is very strong here. The best venture capital funds in the world are in Israel and looking for opportunities."

Fiscal deficit? War? The shekel radiates stability

The Tel Aviv Stock Exchange lags behind Wall Street and foreign investors are exiting from Israeli stocks and bonds, but another indicator radiates surprising stability: the shekel. Since early May, the shekel-dollar has moved in the NIS 3.65-3.72/$ range, and the high volatility that characterized the foreign exchange market has all but disappeared.

What’s happening on the foreign exchange market?

"The strength of the shekel is one of the really interesting questions, and it stands in complete contrast to the other trends that we are seeing. To take May as an example, we saw Israeli government bonds fall, we saw our stock market lagging substantially behind overseas markets, and, somehow, the shekel was one of the strongest currencies in the world against the US dollar."

Costica lists three reasons: "First of all, Israel has a current account surplus. We take in more dollars than we send out. Israel is a large exporter of gas, and that’s very significant. Even Egypt, at the height of the crisis, expanded its contract with the Israel gas reservoirs, for the simple reason that it desperately needs electricity. Secondly, the high-tech industry continues to export in high volumes, and the activity of the defense companies also contributes. In this context, we need to pay attention to the risk of boycotts, such as we saw with the cancelation by Brazil of a contract with Elbit.

"The third and most important thing in my view is transactions by the financial institutions. Although they are continually expanding their overseas holdings, they are still maintaining a balance of exposure to foreign currency of about 25% on average. When they invest more in foreign assets, they sell dollars, and basically hedge their overseas holdings."

What do you think will happen if the fighting in the north broadens?

"If there’s a serious security event, we could certainly see the shekel weakening to NIS 3.9/$ or more. In my personal opinion, if we were to neutralize all the negative external factors, the shekel’s natural place should be a prefix of 3 - we were very close to that in 2021, when high-tech was flourishing and everything looked rosy. On the other hand, we could easily return to levels of NIS 4 to the dollar or more, if things deteriorate. The Bank of Israel will probably intervene at such levels."

The last time that the shekel-dollar rate exceeded NIS 4/$, when the war broke out, the Bank of Israel did intervene, and announced a program of selling dollars to the tune of $30 billion. In the first two months of the war, mainly in October, the central bank sold $8.5 billion to strengthen the shekel. It worked. Since then, the shekel has been fairly stable against the dollar, at around NIS 3.7/$.

Why is the local stock market affected more than the shekel?

"First of all, we have to talk about the structure of the Israeli stock market," Costica explains. "We are the startup nation, but the problem is that we don’t get that in our stock indices. To take the Tel Aviv 125 Index: it has in it companies like Camtek and Nova, which belong to the semiconductor sector and have performed amazingly well, but most of the stocks in the index belong to traditional sectors like banking, insurance, real estate, and industry. That’s absurd in relation to Israel’s real economic mix, and creates a built-in gap versus indices like the S&P 500 in the US, in which the weight of technology stocks is close to 50%.

"Secondly, the security situation of course has an impact. Besides foreign investors, Israeli investors too ultimately think about where they will make the best return. We have seen this in the current reporting season: companies that benefit from the situation, such as defense companies, alongside companies that took a hit in the first quarter because of delayed imports, and rises in shipping and inputs prices. I assume that we’ll see a larger negative impact in the second quarter."

What are the chances of a correction?

"Very large gaps opened up versus the US in May. There could conceivably be a correction, but as long as there’s no change in the security situation here, it will be very hard for us to close these gaps, even though some sectors are traded at very low p/e ratios. As they say, sometime things are rightly cheap."

Published by Globes, Israel business news - en.globes.co.il - on June 9, 2024.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2024.

Yotav Costica  credit: More Mutual Funds
Yotav Costica credit: More Mutual Funds
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