Does Israel’s Record-high Stock Market Spell Bubble Trouble?

The TA-25 index has finally broken its previous peak, but there could still be good reason to keep climbing.

Wednesday was a memorable day for the Tel Aviv Stock Exchange as the blue-chip TA-25 index finished above 1,344 - six points higher than the previous all-time high set in April 2011.

Does this mean the economic crisis is behind us and we’re headed for more stock-market gains and the growth we’ve known in the past? Yes and no.

Yes because the global and Israeli economies are definitely showing signs of stabilizing in anticipation of a period of growth. No because the risks threatening the world economy and stock markets are still hovering in the shadows.

Which threats? The rock-bottom interest rate, for example, could be excessively fueling prices of risky assets. Then there’s the European debt crisis, which hasn’t really been resolved. Or the Chinese real-estate bubble which, if it pops, could expose an ugly side to the world’s fastest-growing economy.

The threats exist. There will always be threats. But as of the third week of November they seem much less foreboding than at the end of 2008 or in mid-2011. In any case, the Israeli stock-market record wasn’t reached in a vacuum but was underpinned by the record levels enjoyed by other stock markets around the world.

For instance, the U.S. S&P 500 index, considered the No. 1 barometer of the U.S. economy, has been in record-breaking territory since March; it has risen an astounding 160% since bottoming out in March 2009. Frankfurt’s DAX blue-chip index, which climbed 29% over the past year, has also been at unprecedented heights for the last six months. And London’s FTSE 100 index has been closing in on a new record for a long time now.

Israel’s stock indexes had been lagging far behind foreign indexes over the last two and a half years and are actually just closing the gap with the rest of the world. We can assume that Tel Aviv traders and investors will continue to smile if indexes in the rest of the Western world continue rising and breaking records.

Public still on the fence

Investors and commentators often reflexively assume there’s a bubble whenever stock indexes hit a new record. So, to put everyone’s mind at ease, the Tel Aviv stock market - like those in New York, London and Frankfurt - is far from being a bubble.

Just look at the price-earnings ratios, a main indicator for evaluating prices by comparing a company’s share price to its profits. P/E ratios of 14 to 16 generally reflect a fair price level. The median P/E ratio in the TA-25 currently stands at 13, still below its multiyear average. There’s no exact science here, but prices look reasonable even if they’re no longer bargains.

Also, a bubble is no less psychological than economic. The Tel Aviv stock market and its record-setting share and bond indexes probably won’t be tonight’s topic of dinner conversation. More interest this weekend will revolve around Iran’s nuclear program and the allegations that singer Eyal Golan had sex with underage girls.

The absence of retail investors in the stock market is apparent from trading volumes, which are still low compared to peak periods in the past. Although turnover has picked up over the past two months to around NIS 1.5 billion a day, it’s still about 30% less than in 2007 and 2010, when activity was strong.

For the most part, the public has left the market to professionals – also a sign that prices aren’t too high.

Economy reasonable, if not good

The last time indexes peaked was right before the summer-of-2011 cost-of-living demonstrations. The protest arose to a large extent because of the people’s pessimism about the future. This was exacerbated by the European debt crisis becoming fully apparent that spring and the U.S. debt-ceiling crisis that August. Suffocating government debt forced some countries to institute sweeping reforms and austerity measures.

In the past year Israel also needed deep cuts in the state budget to forestall a burgeoning deficit. The deficit target was raised to 4.3% of national output to avoid cutting spending too drastically.

It’s now clear that the budget cutbacks did the job and that the deficit, now around 3.5%, will probably fall far short of 4%. Faith in government policy has been upheld.

This faith is also demonstrated by the very low yields on government bonds and the shekel’s strength. Israel’s low unemployment rate of 6% also provides a reason for optimism. The economy is also receiving a strong boost from the natural gas that has begun flowing from the Tamar offshore field. So the economic indicators don’t seem bad at all, and the stock market is certainly likely to rise if the indicators stay as they are or improve.

Companies stabilizing, profits growing

The financial press naturally tends to emphasize criticism and negative outlooks. For instance, the debt restructurings by IDB and Moti Zisser’s group get lots of play due to the drama and emotions involved. The problems of Oil Refineries (Bazan) and Teva Pharmaceutical Industries have also received high ratings because of their volatile potential.

Much less broadcast time or column inches are dedicated to companies that stabilize financially – as many have done. On an inside page you could read, for instance, how Electra Real Estate has turned itself around nicely over the past few months. Only eight months ago the company, under the controlling ownership of the Zelkind family, seemed headed for a debt settlement.

But having shed a string of assets, it has restored its stability and is preparing to raise new capital. Eliezer Fishman’s real estate companies underwent a similar process, and the Eurocom-B Communications-Bezeq communications group rehabilitated itself financially and recently resumed raising capital, not to mention the banks that increased their core capital adequacy ratios and whose balance sheets look stronger than ever.

Operations have improved, too. Retail fashion chains like Golf & Co. and Fox-Wizel have improved their bottom lines. Strauss Group is about to float stock to expand its coffee business abroad. The cellphone companies have stabilized their profits despite mounting competition and have even resumed paying dividends. Residential-housing companies continue enjoying rising demand for new homes, and business at high-tech companies seems healthier than ever.

These things don’t capture front-page headlines or open news broadcasts, but they’re the fuel that drives stock indexes toward new records.

Geopolitical risks off the agenda

One of the main factors casting a pall over the Israeli stock market in recent years has been the political turmoil in Egypt and Syria. Civil war across the border isn’t exactly a recipe for attracting foreign capital. The absence of foreign investors is evident both in stock-market trading volumes and foreigners’ lack of interest in tangible investment in Israel, except in high-tech.

It’s hard to fathom whether the geopolitical situation has really stabilized. In any case, it seems the conflicts in neighboring countries aren’t spilling across the border.

Investors, at least the Israelis among them, have become accustomed to the new type of geopolitical uncertainty and are willing to increase the funds put down on risky assets in Tel Aviv. They’re doing so in the belief that the gains they’ve enjoyed in recent months will continue and that the economic situation is good enough to override the political/security risk shadowing Israel for the past 65 years.

Ariel Schalit