Israel Spasm Pierces Market Parallel Universe
The Tel Aviv Stock Exchange, after a brief fall, ended down only 0.5% during the first week of the conflict, with the local index up 9.4% so far this year. The USD 280 billion market outperformed the over-valued shekel which dropped 3%. The Bank of Israel has for months been buying up FX to rein in the appreciating currency, boosting reserves to near USD 200 billion. Early in the year the monetary authority committed to USD 30 billion of FX purchases this year, higher than the USD 21 billion it bought in 2020, and in the first four months bought nearly USD 20 billion with reserves now almost 50% of GDP.
Prior to the outbreak of violence, investors shook off the lack of government after four elections in two years, three years without a budget, deflation, and pandemic shutdowns. Israel’s economy only contracted 2.6% in 2020, with high tech expanding. Last year direct investment in the technology sector surged 20% over 2019 to USD 9.5 billion. In Q1 30 companies launched IPOs, raising nearly USD 1 billion, while tech start-ups raised a record USD 5.4 billion. The composition of the local stock market has shifted dramatically in recent years, with tech companies now accounting for 38% of market capitalization, overtaking financial services at 30%. To attract even more tech listings, the Tel Aviv Stock Exchange is launching the TA-Dual Listing Index with 44 companies to encourage overseas listed companies to list at home as well. It targets the 21 Israeli-founded “unicorns” in New York, the number doubling over the past six months. The stock exchange has also launched a new platform, TASE UP, which allows tech companies to raise capital but remain private.
The barrage between Israel and the Palestinians reflecting stagnant diplomacy and the territories’ abject poverty will derail moderate Arab country “Abraham Accord” momentum. The United Arab Emirates had announced a USD 10 billion Israel investment fund targeting infrastructure, cybersecurity, fintech and agri-tech, as the Abu Dhabi Investment Office opened a branch in Tel Aviv to forge agreements. In the first five months after the Abraham Accords were signed in October, more than 130,000 Israelis visited the UAE and the bilateral tech zone, connecting investors and entrepreneurs from both countries, has attracted more than 1,000 people and companies.
The IMF upgraded this year’s GDP growth forecast to 5% but warned of a potential wave of bankruptcies when pandemic aid stops in June. It noted that Israel’s deep-seated problems are “inequality, poverty, and a severe lack of skill among part of the workforce,” with solutions postponed from the “complicated political situation.” The Bank of Israel similarly urged the government to “get its political house in order and pass an updated budget,” with the last one three years old. The pandemic sent government debt/GDP from 60% to 73%, the highest in a decade, while the fiscal deficit soared from 3.7% of GDP to 11.6% and is likely to remain at double-digits this year. In contrast, the current account surplus hit a record high, topping USD 20 billion, 4.8% of GDP, boosted by strong foreign direct investment and tech exports.
Within days of the outbreak of violence, ratings agencies weighed in as Standard & Poor’s affirmed its AA- and maintained a stable outlook but warned ratings pressure “could build if security and political risks tied to the current flare up are protracted.” Fitch Ratings said that the clashes “will have only contained adverse effects on Israel’s economy and credit metrics,” but will again frustrate the task of forming a stable government. After Prime Minister Netanyahu failed to form a government for the fourth time, Yair Lapid, formerly a Finance Minister under Netanyahu and liberal TV anchor and one of the few leading politicians expressing support for a two-state solution, was tapped to try. He seeks a cross-party spectrum “unity” government which would likely be weak and short-lived.
Security and humanitarian concerns will continue to be elevated until a cease fire is agreed and maintained. The risk of another election will likely dampen investor interest as the high fiscal deficit worsens from the conflict. The thousands of Iron Dome missiles that have been fired alone cost an estimated USD 50,000-USD 80,000 each, according to media reports, while reserve soldiers who have been called up are an opportunity and real cost for civilian occupation interruption. As the Abraham Accords headline breakthrough stalls, the technology sector will continue to attract investment – Intel announced plans for a new USD 10 billion plant and USD 600 million in new R&D last week. The latest convulsion after an over 5-year hiatus in war footing is an overarching reminder of the geopolitical powder keg that wafts over even remotely-related venture capital startups, and return on equity projections will more regularly elevate this downplayed recent cycle risk.