Merrill Lynch

(NYSE:MEL) has downgraded Israel's stock exchange from Neutral to Underweight,

Ha'aretz

reports.

The Tel Aviv Stock Exchange downgrade was prompted by fears that Likud leader Ariel Sharon will win the prime ministerial elections, scheduled for February 6. The bank worries that a Sharon win could "damage sentiment toward the market".

Meanwhile, Merrill Lynch upgraded the Egyptian stock exchange from Neutral to Overweight, mainly because Egyptian shares are at an all-time low.

The downgrade means that Merrill Lynch is recommending that investors decrease the component of Israeli shares in their emerging-markets indexed portfolios. Sources in the Israeli market said that the downgrading is serious and could lead to money being withdrawn from the Israeli market.

On the other hand, the bank noted that if the Nasdaq corrects upwards, Israeli tech stocks listed on the exchange would benefit. Israeli stocks would also benefit from interest rate cuts.