Tel Aviv stocks retreated Tuesday morning on growing fears of a sovereign downgrade coupled with escalating violence between Israelis and the Palestinians.

Goldman Sachs today joined the chorus of analysts expecting the rating agencies to pounce on Israel's paper and cut it from A-minus to BBB+, indicating a sour outlook for the Israeli economy. Analyst Daniel Tenengauzer said that after Standard and Poor's downgraded the big banks to BBB+, the sovereign nation is likely to follow.

Also, Nasdaq sank 3% yesterday to a six-year low, attesting that the U.S. is still deeply mired in recession. That was not likely to lift the mood on the Tel Aviv Stock Exchange, nor was the rumbling in the territories as Israel and the Palestinians continue to wrestle. The murder yesterday of an Israeli and the grave injuries suffered by his three children in Hebron made the front pages of all the papers, as did the deluge of warnings about imminent terror attacks inside Israel proper.

The Maof-25 index finished down 1.6% to 349.6 points, after starting on a 1% slump. The TA-100 index dropped 1.5% to 341.1 points. Tech stocks fell by 2.7%, weighed down by the dual-listed stocks on Nasdaq, which opened with negative arbitrage spreads.

The shekel stood quite firm today despite the eruption of violence, lifting the dollar to a representative rate of NIS 4.831 and sending bond prices reeling and yields rising. But after closing, the dollar rate continued to climb, rising half a percent above its official rate to NIS 4.855.

DBM Investment House manager Rami Dror said this is the second crisis the bond market has undergone in three months, the last being when the shekel shrank to five to the dollar in July. Then too the crisis was sparked by institutional investors shying away from bonds with yields that have climbed to 11% and beyond.

Even at 13% the institutionals are seen unlikely to support the market, which could ignite a panic among the general public, which has not yet begun abandoning its shekel vehicles. "When that happens, we may reach a situation never seen before," Dror said.

Bonds fluctuated violently before the session closed, with fixed-interest long-term Shahar bonds ending down 0.2% to 0.3%, after starting on a gain of about that magnitude. Series 2860 bonds of 8.5 year terms to redemption ended on a loss of 0.3%, reflecting yields of 11.1%. Series 2671 6.5-year bonds reflected yields of 11.09% after ebbing by 0.2%.

Ronen Avigdor, manager of the Excellence brokerage's mutuals, noted that the bond and currency markets are being controlled by foreign speculators. "Despite that, or maybe because of it, the financial markets are not about to collapse," he added. "Most of the public's assets have been transferred to bank deposits and not much is left in tradable vehicles. The arena belongs to the foreigners now."

As for the stocks, one major mover today was

Israel Salt Industries (TASE:

SALT

), which tumbled by 22% on thin turnover of NIS 200,000. Market players attributed the slide to the loss by Bank Hapoalim stock. Salt Industries holds a controlling stake in Bank Hapoalim, Israel's biggest bank. Market sources say Salt Industries may have to write down Hapoalim's valuation in its books.

The banks were back in disfavor after a correction on Monday.

Bank Hapoalim (TASE:

POLI

) fell by 1% and

Bank Leumi (TASE:

LUMI

) dropped 0.9%. Both were downgraded last Wednesday to BBB+, from A-minus, which fact is expected to reduce Israel's sovereign paper to that lower level too. The Israeli rating agency Maalot also said yesterday that it will be re-examining the two banks' rating, which currently stands at AAA.

Teva Pharmaceuticals

(Nasdaq:

TEVA

) ascended by 0.3%, exactly the magnitude of its arbitrage gap with Nasdaq. It was the friskiest stock on the floor today, with a volume of NIS 32 million, while the total turnover on the TASE today was only NIS 154 million.

IDB group stocks are in the doghouse, with

IDB Development Corporation (TASE:

IDBD

) down 2.7%,

Discount Investment Corporation (TASE:

DISI

) losing 2.6% and

Clal Industries and Investments (TASE:

CII

) off by 2.5%.

IDB Holding Corporation (TASE:

IDBH

) reversed from a mild morning gain to lose 2.4%.

Makhteshim Agan Industries (TASE:

MAIN

) dropped 3.3% on heavy turnover of NIS 5.8 million, thanks to the Brazilian real's 13.3% devaluation against the American dollar. Brazil is a key market for the Israeli fertilizer producer, contributing between 30% to 40% of the company's sales revenues.