Israel ETFs and the Gaza Factor

Nearly a decade ago, a former director of Mossad (Israel’s national intelligence agency) explained to this writer that, despite their “public commitment to wipe out the Jewish State, organizations like Hamas and Islamic Jihad simply cannot sustain a conflict long enough to damage Israel’s social fabric.” If that conclusion holds true today, investors trading Israel Exchange-traded Funds (EIS, ISL, AMDEX) or Israel-based shares need only ground their positions on the exposure of the Israeli economy to the global recession.

The Jerusalem Post (January 14, 2009) suggested that MSCI Inc.’s recent decision to delay upgrading the Tel Aviv bourse from emerging to developed status may have been influenced by the conflict in Gaza, and by the possibility of a wider conflict with Hezbollah in Lebanon. One factor determining the MSCI decision is clearly the state of the global economy. But MSCI is misreading the Gaza conflict in its most fundamental respect, if at all the Jerusalem Post’s doubts are valid.

This writer’s view is that Israel ETFs are short propositions today, and whenever they approach pre-November peaks. But that view is not predicated on developments on and around Israel’s borders. In fact, it is important to remove wider-war-related doubts in order to arrive at a genuine perspective on the 2009 direction of Israeli shares.

Despite any recent and not-so-recent statements made by government officials in Tel Aviv and Jerusalem, many Mossad veterans are convinced that Israel won the war it needed to win way back in the late 1980s, when the collapse of the Soviet Union considerably weakened left-wing Arab groups in the Palestinian Territories, in Jordan and in Lebanon. “Contrary to the agenda of socialist and communist groups, the Islamists in this region do not have economic betterment, worker rights, land reforms, education and women’s emancipation on their political platforms, so they are unable to engage the Jewish State with any degree of durable commitment from the population,” the former director had reiterated. “We are not threatened by mass movements for comprehensive social change in the region, like the Sandinista movement in Nicaragua, or the liberation wars in Mozambique and Angola or even the anti-apartheid struggle in South Africa.” In brief, periodic flare-ups apart, there is no credible or sustainable threat to the Jewish State.

Tel Aviv, which lost 46% in 2008, received developed-market status from London’s FTSE group in late 2007. A similar move by the MSCI will no doubt allow numerous mutual funds and a pool of hundreds of thousands of pro-Israel investors, to buy and sell Israeli shares. So the ingredients of a major upward move, at some point in the future, in the TA-25 (Israel’s benchmark index) are in place, given Israel’s renewed focus on corporate governance.

But, in this writer’s opinion, the upward move can only follow a further, overdue adjustment in asset values. This short call envisages a 25% decline in the TA-25 from yesterday’s levels. Certain sections of the Israeli economy (exports of high-tech equipment, diamonds and food items) remain extremely vulnerable to deteriorating global conditions. And, internally, the rise in real unemployment levels to 10% and beyond (not the official employment rate) will continue to curtail domestic demand.

Furthermore, the Israeli shekel is now under pressure due to concerns about Israel’s credit rating, though Moody’s retained its “stable” outlook on Israel’s “A1” rating last week. Credit default swap spreads on 5-year Israel risk are being quoted in the 160-190 bps range, in line with similarly-rated sovereigns; but price-makers are indicating that the range is skewed against the asked side, and that a move to 210 bps-plus is imminent.

Finally, this writer is aware of the “Iran factor” in the Israeli equation. But, by all accounts, with 25% real unemployment, with 750,000 new entrants into the workforce each year, with two-thirds of the population under the age of 30 and with dwindling surpluses for welfare programmes due to falling energy prices, the Islamists in Teheran will be too preoccupied with the dreaded prospect of internal dissent for the rest of this decade to worry about “eradicating the Jewish State from the face of the earth.”

Disclosure: no positions

Comments

[guliamo:]

Fantastic post - great insights.

Jan 16 05:29 AM

[AJB7:]

A quite interesting article with originality of thought. I particularly appreciated the discussion of the TA-25 index prospects, as I have held short postions in Israeli ETFs in the past. Personally, however, I am not quite as convinced that Israel's economic prospects can be so clearly divided from its geo-political realities as Saxena assumes. Briefly, any region so regularly engulfed in minor and major wars for the last half century must have these probabilities taken into account for the future, both on a long and short term basis. In my opinion at least, the last chance that there could have been a major settlement of these disputes was missed (by both sides in my opinion) at Camp David in 2000. Political and military realities have only worsened since then, so it is unlikely that there will be an permanent peace in this region for any forseeable future that I can see.

Secondly, as I understand it, one strength of the Israeli economy is US subsidies of various sorts. But perhaps inperceptibly at present, there is a growing questioning of this support in some circles. The book the Israeli Lobby was one indication of this, but a larger question occuring to some people is simply what is the current strategic value of Israel to the US, certainly compared to its costs in a wider geopolitical framework. In a private conversation with one very senior security official in the Clinton administration, it was admited to me that there was none, other than perhaps the need to stand with an ally to assure other allies that the US support is unwavering in all circumstances. Still, while I do not believe Obama is "anti-Isreal" as he was sometimes portrayed in the campaign, should these private questionings grow public, long term financial support to Israel cannot be taken for granted. Israel after all, is not the 51st state.

Finally, Saxena's perspective on the dangers from Iran is counter to a widely helf political perspective, that countries facing internal discord or malcontent seek to create foreign enemy scapegoats to divert domestic attention, a viewpoint best portrayed in Orwell's novel 1984. If this viewpoint is correct (as I believe it is), not only will Iran not be preoccupied by its internal troubles, it is likely to heighten tensions with Israel in an ideological sense, and very likely with a blackmail threat of a nuclear bomb on an intermediate range missle. Not a particularly good investment environment.

Jan 16 09:04 PM

[Rakesh Saxena:]

Dear AJB7: You provide a good perspective and I will certainly reconsider the Iran factor in the light of your comments. I am waiting to study the internal situation there in depth over the next few days and will write on the Iran issue shortly, not only with respect to Israel but also with respect to oil (Straits of Hormuz) and Iraq. Many thanks - Rakesh


On Jan 16 09:04 PM AJB7 wrote:

> A quite interesting article with originality of thought. I particularly
> appreciated the discussion of the TA-25 index prospects, as I have
> held short postions in Israeli ETFs in the past. Personally, however,
> I am not quite as convinced that Israel's economic prospects can
> be so clearly divided from its geo-political realities as Saxena
> assumes. Briefly, any region so regularly engulfed in minor and major
> wars for the last half century must have these probabilities taken
> into account for the future, both on a long and short term basis.
> In my opinion at least, the last chance that there could have been
> a major settlement of these disputes was missed (by both sides in
> my opinion) at Camp David in 2000. Political and military realities
> have only worsened since then, so it is unlikely that there will
> be an permanent peace in this region for any forseeable future that
> I can see.
>
> Secondly, as I understand it, one strength of the Israeli economy
> is US subsidies of various sorts. But perhaps inperceptibly at present,
> there is a growing questioning of this support in some circles. The
> book the Israeli Lobby was one indication of this, but a larger question
> occuring to some people is simply what is the current strategic value
> of Israel to the US, certainly compared to its costs in a wider geopolitical
> framework. In a private conversation with one very senior security
> official in the Clinton administration, it was admited to me that
> there was none, other than perhaps the need to stand with an ally
> to assure other allies that the US support is unwavering in all circumstances.
> Still, while I do not believe Obama is "anti-Isreal"... as he was
> sometimes portrayed in the campaign, should these private questionings
> grow public, long term financial support to Israel cannot be taken
> for granted. Israel after all, is not the 51st state.
>
> Finally, Saxena's perspective on the dangers from Iran is counter
> to a widely helf political perspective, that countries facing internal
> discord or malcontent seek to create foreign enemy scapegoats to
> divert domestic attention, a viewpoint best portrayed in Orwell's
> novel 1984. If this viewpoint is correct (as I believe it is), not
> only will Iran not be preoccupied by its internal troubles, it is
> likely to heighten tensions with Israel in an ideological sense,
> and very likely with a blackmail threat of a nuclear bomb on an intermediate
> range missle. Not a particularly good investment environment.

Jan 17 12:34 PM

[freefall51:]

Rakesh,

you master an amazing spectrum of issues. I am always waiting for your next one. Very good.

Jan 19 05:27 PM

[Rakesh Saxena:]

Thanks freefall51. I am getting to work now after the long weekend. - Rakesh


On Jan 19 05:27 PM freefall51 wrote:

> Rakesh,
>
> you master an amazing spectrum of issues. I am always waiting for
> your next one. Very good.
>

Jan 19 10:55 PM