As Israel heads for elections on March 28, investors are wondering whether a political change will stoke or subdue its booming economy. Will the elections bring a dramatically different administration? Many in the local financial markets believe they won't, but market participants remain on the lookout as geopolitical threats loom in the region. It is widely anticipated that Kadima, Ariel Sharon's newly established party now headed by Ehud Olmert, situated in the center of Israel's political map, will by itself win a majority of the votes and will be responsible for building a new, wide-coalition government. One possibility is that the Likud, Benjamin Netanyahu's right-wing party, joins the coalition, together with smaller religious groups. Another is that Amir Peretz, head of the Labor Party, joins the coalition, accompanied by other left-wing and secular parties. It is also possible that both Netanyahu and Peretz join Kadima, though it is less likely. One thing is for sure: Both Peretz and Netanyahu will want to be finance minister; the "socialist" (Peretz) and the "capitalist"(Netanyahu) will fight to shape Israel's socio-economic policies. In the financial community, the tendency is to prefer Netanyahu's privatization and tax-cut strategy, which is said to have contributed to Israel's 5.2% GDP growth in 2005. But his right-wing stance with regard to the Palestinians will probably prevent him from winning the election. "The Iranian threat, and the fact that Israel is not the only one facing a government change, but also the Palestinian authority is, with Hamas, are more critical to Israel's future than what party will end up winning," said Danny Farhi, head of institutional sales at Excellence Nessuah, an Israeli financial services firm. "It is pretty obvious that Olmert will be the next prime minister," Farhi said. "He is going to have to prove himself by performing something along the lines of Sharon's unilateral withdrawal from Gaza. It will just take some time until it happens."
Meanwhile, the eyes of the local money managers are on foreign investors; these money managers are ready to act on the first sign of an exit. After a record year of foreign investments in Israeli securities, which nearly doubled the average trading volume on the Tel Aviv Stock Exchange (TASE) and fueled a 30% rally in the TA 100 index in 2005, many are concerned that most of the securities have already reached their full market value. Since the beginning of the year, the index is up less than 5%. Ronen Zeharia, chief investment officer at Meitav, an investment firm, said, "I wouldn't attribute too much importance to the elections, but the market is not in a general discount. I recommend being selective about picking stocks rather than buying ETFs or indices." Israeli banks, such Bank Hapoalim and Bank Leumi, which have attracted foreign investors because of their high dividend yield and liquidity, could be more susceptible to geopolitical events in the country. "You buy the banks, you buy the market," Farhi said. He added that the industry could take a hit under an extreme scenario where the Israeli-Palestinian situation worsens or "someone decides to attack the Iranian nuclear plant." The Israeli banks index has risen more than 60% year to date. Perhaps one warning sign is the recent drop in Middle Eastern stock markets such as those in Kuwait and Dubai, which fell roughly 17% and 12% respectively over the past month and a half. The declines were largely attributed to a rapid exit of foreign investors. Media reports said investors pulled out their money because of a lack of transparency, too much government ownership and too many public offerings at inflated valuations. That isn't the case at the TASE, but it does demonstrate what happens when foreign investors have had enough of something.
"In 2005, emerging markets received massive investments, which in many cases caused prices to inflate. There is some concern that this trend will become an emerging-markets bubble, and Israel, inevitably, is part of that," Zeharia said. Also on investors' minds are some recent macro data showing a slowdown in Israel's economic growth to 4% in 2006. The Bank of Israel is expected to raise interest rates by a quarter of a percentage point to 5% next week, a day before the elections. Some Israeli publicly traded companies, especially those that are export-oriented, have a better chance to continue booming in the case of political unrest or a sudden flight of foreign money. Zeharia, who is long the stocks he recommends, likes Elbit Systems ( ELST), which manufactures defense electronics systems and upgrades defense platforms for Western and former Eastern bloc armies. The company currently trades at 15 times its 2006 earnings estimate, according to Thomson Financial, compared with a defense industry average multiple of 19. Its U.S. peer, Raytheon ( RTN), trades at 17.8 times its 2006 projected earnings. Analysts generally believe average earnings in the defense industry will grow by 15% annually over the next few years. Another popular company among money managers is Israel Chemicals, a $5-billion-market-cap concern traded on the TASE. According to Farhi, who is long the stock, the maker of fertilizers and special chemicals is trading at 11.4 times its 2006 earnings; the TA 25 index it trades in carries an average 2006 earnings multiple of 15. Israel Chemicals is also compared with Syngenta ( SYT) within the fertilizers industry, which currently trades at 15.8 times its 2006 earnings estimates. Farhi expects a 12% growth in Israel Chemicals earnings this year. Retalix ( RTLX), a software company that sells retailing, distribution and supply-chain management applications to convenience stores and gas stations, is an interesting company that is under the radar, in Farhi's opinion. The company recently signed a large software upgrade deal with Tesco, Britain's largest supermarket chain, that is estimated to be worth in the range of $7 million to $10 million a year for roughly 10 years. Retalix currently trades at 29 times its 2006 earnings estimate, relatively expensive compared with some of its peers including Manhattan Associates ( MANH), which trades at 20.8 times its 2006 projected earnings, or JDA Software ( JDAS), which trades at a 21.5 multiple. Retalix will report its 2005 earnings on Monday. A company spokesperson confirmed to TheStreet.com that the company will meet its previous guidance for 2005 net income of roughly $15.5 million.