Michael Wilson looks at the considerable opportunities that exist in Israel, despite its delicate political climate.

To judge by the papers, you might suppose that things are going pretty badly for prime minister Benjamin Netanyahu.
Israel’s premier has been infuriating the United States, his most important ally, with his blockade of the Gaza Strip, the thin tongue of occupied coastal land that leads down to the Egyptian border.

His continued refusal to sign the international nuclear non-proliferation treaty has left Israel sitting in a club of just four, whose other members are Pakistan, India and North Korea.

He has had a personal ear-bashing from President Barack Obama over his provocative decision to approve the building of 1,600 new homes in the occupied West Bank territories, at the exact moment when vice president Joe Biden was visiting Jerusalem to restart a round of hard-won ‘proximity talks’ with the Palestinian leader Mahmoud Abbas. The peace talks, predictably, were stalled.

It’s a welcome surprise, then to hear that Israel’s financial scene seems to be taking no notice and that its economy has been delivering a dream set of numbers.

On 6 April the Tel Aviv TA-25 index soared to an all-time high of 1,237.85 – just pipping the 1,237.13 of October 2007, before the financial crunch of the past 30 months started. That left the index 110 per cent above the lows of November 2008.

And the good news just kept on coming. In the first three months of 2010, the broader-based TA-100 index, which includes all of Israel’s 100 largest listed companies, put on an impressive 9 per cent – equivalent to nearly 15 per cent in sterling terms.

Ability to bounce back
So where’s all the excitement coming from? Well, if you were a cynic you could say it was all a bit of irrational exuberance by the market, in response to a solid and sensible set of policies that have set the Israeli economy more or less back on track after a pretty dire economic crisis at the end of 2008. You might even add that a 110 per cent stock market surge in 18 months has probably mopped up most of the remaining value in the economic rebound by now, and that there’s probably not much more to be extracted. But you might just be wrong.

Israel’s economy grew by an amazing annualised rate of 4.4 per cent in the final quarter of 2009, and current projections for 2010 are running at 3.2 per cent. That’s a good headline figure, undoubtedly, but that doesn’t necessarily tell the whole story.

Israel’s overall growth in 2009 was just 0.7 per cent. In other words, it shrank by quite a lot during the first part of that year. So be careful of the statistics.

Within the country, industry is in good health. National manufacturing output was up by an impressive 4.5 per cent in the 12 months to January – and Israel’s large trade deficit was more than counterbalanced by big cash inflows that left it with a hefty current account surplus. Israel has almost no large-scale consumer industries, but its banks are a big draw for foreigners. Having wisely avoided the sub-prime lending binge that trashed their foreign competitors, they can safely be said to have earned that trust.

A cautious view from abroad
The puzzle is that foreign corporate investors are still giving Israel such a wide berth. The total amount that they invested directly into Israeli companies during 2009 (as distinct from simply buying their shares) plummeted to just $3.8 billion, compared with $10.8 billion in 2008 and $8.8 billion in 2007. So yes, it looks as though those foreign policy disputes with the US might be taking their toll after all. How long can the recovery continue without them?

Israel, understandably, dismisses such concerns, arguing that its unique situation calls for unique solutions. Finance minister Yuval Steinitz told Newsweek magazine in March that the reason for his country’s strong bounce-back was that it had responded quite differently from its rivals after the global economic crisis of 2008.

Instead of cutting interest rates and encouraging consumer spending like the UK or the US, Israel had raised taxes, increased the bank rate (thus boosting the shekel to sometimes uncomfortable levels), and rebuilt its government finances. Yes, this had certainly hurt, he said, but what was the alternative? If Israel had encouraged people to buy cars like America or China, they’d all have been imports anyway and the local industries wouldn’t have benefited at all. Better, surely, to fix the budget and take the short-term pain?

That, in effect, is what Israel has done. Despite all the current animosity from abroad, the recent recovery seems to have been built on entirely sound fundamental principles. Yes, admittedly there are worries. Inflation is too high for comfort, and few people think the government’s target of 3 per cent for this year is achievable. What’s more, unemployment is nearly 7.5 per cent. And there won’t be much change on that front in the foreseeable future.

What would really complete the dream now would be if Netanyahu were able to forge a lasting agreement with the Palestinians over the West Bank occupied territories, so that foreign capital felt more comfortable about backing Israeli enterprises.

Many Palestinians would be prepared, in principle, to accept a compromise that allowed some West Bank settlements to be retained in exchange for Israel’s cast-iron recognition of the ‘two states’ principle. But Netanyahu is not showing much sign of actively wanting to pursue this idea. Besides, he knows that President Obama already has far too much on his own domestic policy plate to feel like forcing Bibi’s arm politically. So we may be waiting a long time for an improved sentiment from Washington.

A place to invest
So what is Israel like as a place to invest? Well, it can be rather volatile, actually, because it’s a small stock market with rather poor ‘liquidity’ – which means that it tends to over-react to events.

Last year’s astonishing 70 per cent stock market growth might look attractive, but you’ll need to decide whether or not it’s left Tel Aviv looking ‘fully valued’, with not much room left for further improvement.

We’d have to say, though, that it’s not an expensive stock market, or not by European standards, anyway. A typical parcel of Israeli shares will carry a price/earnings ratio of about 16, which means that you’re paying 16 times the last recorded profit levels per share for every share you buy.

London has a more affordable p/e of 13, of course, but Paris, Frankfurt and New York are all in the 18 to 22 range.
How do you buy into Israeli shares? Well, it’s a lot easier if you do it through New York rather than through London. Apart from Bank Hapoalim or a food flavouring company called Frutarom, Israeli companies in London tend to be small high-tech operations with correspondingly high risk. Telecoms, gaming software, gambling, biotechnology – you get the idea.

If you crave more stability, you’ll be better off using an exchange-traded fund (ETF) that will simply track the Tel Aviv stock market rather than leaving you vulnerable to individual companies.

One of the best performers is the iShares MSCI Israel Capped Investable Market ETF, which shadows an artificial index called the MSCI Israel Capped Investable Market Index. The bad news, predictably, is that it’s listed in New York and there are no Israel ETFs in London yet.

The good news is it put on a massive 79 per cent in the year to mid-April. And that was in dollar terms, too. For a UK investor, the returns would have been even greater.

It takes courage to suppose that the current uptrend in Israel can continue, but there’s no doubting that the market wants it to succeed. The problems are political, and America’s concerns are not to be dismissed lightly. But you could do a lot worse – especially if you’re in the optimistic camp about Israel’s future.