Twenty years ago, I took a brief trip to Malawi. A painting titled “Death has no escape” was being sold at every bazaar in the country. The painting shows a man stranded in a tree, apparently after starting to chop it down. He is sitting on a branch with a snake above him, a lion below him and a crocodile lurking in the river below.
Over the last year, reading the news has felt like “death has no escape.” I’m not sure who is playing the lion, who is the crocodile and who is the snake but we are entering 2012 menaced by three extremely dangerous creatures, and one could easily argue that our tree is falling because we have been chopping it down.
1) We have overextended ourselves. Global growth was funded by debt for the past three decades. As economies and companies alike blithely assumed that growth would continue to be brisk, they funded the investments needed to sustain this growth by borrowing even more, further reducing ratios of equity to debt. This process was propelled by low-interest rates.
The problem arose when the balance broke down. As the risk premium rose and the rate of growth declined, many banks, companies and economies found themselves over-leveraged to the scary, scary degree where more than one European country is facing bankruptcy. A lot of people stand to lose a lot of money.
The process of reining in debt began in 2008, but there is still a long way to go.
2) The “Walmart syndrome” is an expression coined to describe the limits of capitalism and to explain the rise of the tent movements around the world: Occupy Wall Street in the United States, the Rothschild Boulevard movement in Tel Aviv, the Indignados movement that squatted in Madrid’s Puerta del Sol square and many others. Around the world, a cry arose for social justice.
“Walmart syndrome” is about the imbalance caused by over-efficiency. As the retail store giant grew and became more efficient, its procurement costs dropped below those of competitors. Rivals could choose to be bought out, or be driven out of business. The more Walmart grew, the less it paid for procurement. We could all “pay less, live better” as the chain’s slogan goes. And it paid its employees less and less too.
Thus Walmart and its peers grew larger, and more people got to consume more for less − yet they got paid less in the process.
As these conglomerates grew, the very small group managing them received the wealth they generated. Even though their margins were narrowing, their profits mushroomed as they grew larger. The group of people accumulating the wealth grew increasingly smaller.
We enter 2012 with the understanding, at least in Israel, that this is how companies work.
Changing the process necessitates new regulations. But we also know that given how the government and parliament are structured, it is highly unlikely that economically sound, functional regulation will be passed. That isn’t just because of tensions between economic conservatives and liberals; it’s also because Israel’s ministries do not coordinate their work, and because the higher levels of government lack experienced, professional staff.
3) The Arab spring is taking a worrying turn toward religiosity. To quote a friend who put current events in a historical perspective, “What followed the global cultural and economic evolution in Greece and Rome were the Middle Ages.” Several Middle Eastern countries seem to be facing that unhappy fate. These forces are alive and kicking in Israel, too.
Scary monsters and beautiful beasts
We in Israel enter 2012 surrounded by scary beasts. For investors, this raises the question: Are we doomed? Where can we invest as many industries face increasing regulation, budgets are shrinking, global trade is dwindling (at least that’s what we can expect in the first half of the year), a labor law crackdown and higher payroll expenses are likely, and consumers have increased power driven by Facebook and Groupon? The world may be looking better for us as consumers, but it poses many risks for us as investors.
Over the last year as the Tel Aviv Stock Exchange has declined by 20%, compared to the Nasdaq’s 1% loss (as of December 24), as awareness of the various risk factors increased.
Thus, we should look to invest where we think the market overreacted.
We think both the Israeli gas and oil exploration sector and the commercial real estate sector are now undervalued, and there are some good reasons to expect they might outperform the market in 2012. We would also suggest Israel’s biomed stocks, which include some interesting options. These stocks generally are priced based on the state of their R&D, and have only a small correlation to the market as a whole.
We believe the risk in other sectors such as Israeli banks, food retailers, food manufacturers and telecoms remains high. Some might be interesting long-term investments but given the current atmosphere and price levels, we think the risk still outweighs the potential.
The gas industry. Over the last several years Israel has developed an interesting oil and natural gas exploration industry. Even in a worst-case scenario of recession and declining energy demand, the recently discovered gas reservoirs will inevitably be developed. When they start producing gas, they will likely reduce Israel’s energy costs and dependence on oil, a factor in global warming.
Israel’s first significant gas reservoir, Tethys Sea, was found in 2000. Ten years later, in 2010, Leviathan was discovered − the decade’s largest deep-water gas find. The reserve, off Haifa’s coast, contains an estimated 450 billion cubic meters of gas (16 trillion cubic feet).
At the end of 2010, IBI Investment House oil and gas analyst Guil Bashan downgraded the country’s oil and gas stocks. Now he believes that companies with rights to explore and exploit the fields have become interesting again. This year, their shares were hit by increased regulation and taxation, not to mention fears of economic slowdown and of a global credit crunch, which might delay or add financial risk to future developments.
As often happens in financial markets, we think investors ignored the full half of the cup this year. As a result, many gas and oil shares fell to attractive levels. Regarding the regulatory risks, we believe that given the extreme taxation measures the Israeli government imposed in 2011, further regulatory pressure is highly unlikely.
In 2012, we expect to see development progress on the Tamar reservoir, which should start producing gas by mid-2013. We expect the stakeholders to continue drilling for additional reservoirs in the region, and to start searching for oil, too − which, if found, could create an incredible upside for investors. We also anticipate the regulatory debate to continue over how much − if any − of the gas Israel should export, and whether a gas liquefaction facility should be built for that purpose.
The real estate sector: The local real estate market has correlated inversely to markets elsewhere in the world for the last decade or so. Local real estate prices fell from 2000 to 2008, then started rising as they tanked nearly everywhere else.
More than 40,000 dwellings are in the process of being built in Israel, which would meet a large portion of the built-up excess demand. Quite a few office buildings are being built in and around Tel Aviv, but very few shopping centers and malls are being developed.
In addition, Israel’s commercial real estate sector has undergone a series of mergers and acquisitions over the last two years, creating several large, successful, dominant companies.
We are not blind to the risk facing this sector should Israel’s economy fall into recession. Our argument is that in the meanwhile, given the restructuring, the potential growth in consumers’ purchasing power − should we avoid a recession, and should the low unemployment rate, growing workforce participation and dropping telecom and housing expenses continue − and the large number of new dwellings that will need to be furnished, this sector could have a rosy short-term outlook.
Living with what you have
Biomed − IBI biomed analyst Natalie Gotlieb points out that while established pharmaceutical companies will suffer should government and private sector purchases slow, this is a remote risk for new biomed companies.
Most of the 58 biomed companies traded on the Tel Aviv Stock Exchange are in various stages of clinical trials. Most are expected to start selling a new drug or device that would help reduce treatment costs.
Quite a few companies are expected to face important regulatory thresholds in 2012 while others are in the process of starting to sell, mostly via third parties. Those with enough cash on their balance sheets will obviously have an easier time, and there are several companies with a decent cash cushion.
In this sector, we would recommend looking closely at Clal Biotechnology, D-Pharm, Can-Fite, Bioline and Mazor Robotics, which we believe offer a promising balance between risk and discount.
By the way, any analyst covering pharmaceuticals will tell you that this is an evergreen industry. Why? Antibiotics aside, drugs don’t cure your malady. They generally just treat the symptoms, so you can go on living, often comfortably, with whatever illness or condition you have.
This is a good reason to invest in biomed, and it’s also a useful metaphor for our view of the market as a whole.
It seems that most countries have the medicine to treat and possibly cure the many socioeconomic problems surrounding us as we enter 2012. If the patient is compliant, if the cure for each problem is chosen while considering side effects, we might live prosperously ever after.
Many sectors seem to be higher risk. But others might have less risk than the market as a whole and might be a reasonable place to park your investments for the time being.
As in the Malawian painting the situation seems hopeless, but even one friend with a big gun could change the stranded man’s fate. Past experience in the financial markets shows we can’t predict the future. Our best strategy is to diversify our portfolio, and to look for investment venues with an inverse correlation to the market or with a unique story that puts them apart.
The author is the business development manager at IBI Investment House. This document is based on information published by the companies and evaluations that, due to the nature of things, may prove outdated, inaccurate or incomplete. Investment decisions should not be reached on the basis of this article alone: Its purpose is to provide information only, and it does not constitute counsel or invitation to purchase or sell the securities mentioned herein.
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