Israeli Slowdown Looms as World Economy Cools

Economists’ warning comes as government reports that GDP growth slid in the second half of 2018

A sign stands outside the headquarters of Israel's central bank in Jerusalem, August 19, 2013.
Bloomberg

The global economy is headed for a slowdown and perhaps even a recession, and Israel will be swallowed up in it.

That was the talk at an investor conference this week in Tel Aviv, where some economists warned that the threat was magnified by the fact that neither the Bank of Israel nor the government has the means to cope with a downturn.

“There’s a consensus that we’re near the end of a positive global economic cycle and the only question is whether it will end in a slowdown or a recession,” Zvi Stepak, co-founder and chairman of the Meitav Dash investment house, told the conference Sunday.

“The slowdown in Israel won’t be negligible,” he said. “If in 2018 economic growth in Israel exceeded 3%, the forecasts are that in 2019 it will be about 0.5 percentage point less. That’s not a recession, but it is a slowdown. Israel is a small market and it’s influenced by trends in global trade.”

The gloomy forecasts came as the Central Bureau of Statistics reported that gross domestic product grew by a strong 3.3% last year. However, the pace of growth slowed sharply in the second half, to an annualized 2.2% from 3.4% in the first half of 2018 and 4.3% in the second half of 2017.

Ofer Klein, the head of economics and research at Harel Insurance and Finance, noted in a published comment Sunday that the growth was led by a surge in consumer spending and in investment. While consumer spending is expected to slow this year, he said Israel’s overall economy was on track to expand by 3.2%, only slightly less than in 2018.

Ori Greenfeld, the chief economist and strategist of Psagot Investment House, said that while Israel can’t shelter itself from global developments, it is in a relatively strong position to weather them.

“The bad news is that Israel will be entering a slowdown. The good news is that since interest rates have been rising slowly in the United States and not at all in the rest of the world, we’re facing a slowdown and a recession but not a crisis,” he said.

Economic activity in Israel remains strong, he said: Wages are rising, unemployment remains low and the Bank of Israel, despite a one-time rate hike in November, remains expansionary. “I believe the local economy remains strong, but we will feel the impact of slowing exports,” Greenfeld said.

Stepak, on the other hand, expressed concern that neither the Bank of Israel nor the government would be able to cope adequately with any slowdown.

“When the budget deficit is growing and the Bank of Israel interest rate is just 0.25%, the tools they have to cope with a serious slowdown are poor,” Stepak said. “There’s no room for lowering interest rates, in contrast to the situation in the U.S. On the fiscal front, they can’t risk raising taxes when the economic situation is growing worse.”

For Israeli investors, Stepak and Greenfeld recommended reducing exposure to overseas investments and putting more money in the local market as well as adopting a defensive strategy that prioritizes keeping the risk of losing principal to a minimum.

“In a world coping with a major slowdown, an investment portfolio has to be defensive. That is especially the case in the U.S., less so in emerging markets and not at all in Europe, where [asset] prices are low,” said Greenfeld.

In that scenario, Israel emerges as a defensive market, he said. “Israel should be 50% of share allocation, with the remainder in the strongest European countries, mainly Germany,” he recommended. “Israel looks good economically — interest rates are going down and that’s a positive for business activity.”

The weighting toward Israel marks a sea change in investment strategy, after years when institutional and private investors favored overseas markets, especially the U.S.

Stepak agreed. “In a allocation between Israel and abroad, the Israeli market is among the cheapest in the world, in my opinion. By contrast, the U.S. market is among the most expensive globally, despite the recent declines.”

On the other hand, Wall Street remains a very liquid market with companies that lead the world in innovation and technology, so investors can’t avoid it entirely. Stepak recommended that Israeli investors keep 45% to 50% of their equity portfolios in Israel. Of the rest, half should go to the U.S. and Japan. “In Europe, I would invest less even though prices are low,” he added.

As for emerging markets, Stepak said they presented an interesting dilemma for investors. On the one hand, they are relatively cheap; on the other, they present outsized risks. “One of the main risks was the aggressive policies of the U.S. Federal Reserve, but in my opinion that risk has eased for now,” he said, referring to the Fed’s decision to take a break from its policy of steady rate hikes.