War and Stocks, Q&A

Why are stocks falling?

Because the war inevitably impacts the Israeli economy, and the companies traded on the stock exchange.

Why did stocks suddenly jump on Sunday?

Crises are characterized by intense volatility. Rumors can have a huge impact. The arrival of upbeat information (that may later prove to be untrue) lifts the market, and bad news (ditto) flattens it. So far, the war has cost investors tens of billions of shekels.

Until now everybody, including you at TheMarker, recommended Israeli stocks. A few days of rockets causes that much damage?

We do believe that the Israeli economy has done impressively well, and that the fundamentals are sound. That is what fueled the gains on the stock market in recent years. But, and it's a big but. The war in the north brings surprise into the equation.

Share prices and bond prices, and the exchange rate of the shekel, are based not on past performance or the present, but mainly on expectations. The stock market digests new information and reacts accordingly: and the war has blackened any rosy expectations.

How much damage can the war do to the economy?

We don't know yet, because we don't know when and how it will end. That uncertainty is one of the main reasons stocks have been tanking.  Investors price the risk that the war will drag on, and the risk that Syria and Iran will join.

The damage the press has been reporting, tens of millions here and there, is merely the direct damage. Most people living north of Tiberias live mainly off tourism, an industry that should have peaked in summer, but which has been ruined for the year.

Everybody says tourism is a tiny fraction of Israel's business product.

Yes, but the harm is not only to tourism. Real estate and the stock market itself flourished in the last two years because of the massive entry of foreign investors. The gigantic deal in which Warren Buffett bought 80% of Iscar for $4 billion has been completed, but the influx of $150 million a month to Israel's housing market could dry up overnight, which would be horrible for the real estate sector.

What indirect damage could be caused?

1. Private consumption: The public has been feeling prosperous, a feeling that has been hurt by the slide on the stock market and the missiles landing on its confidence. Rallying private consumption has been a major economic growth driver for two years; and the malls and cinemas could empty out. Worried people glued to their TVs aren't out there shopping or clicking glasses at a restaurant.

2. The risk premium: Technically, that boils down to the spread between Israeli government bonds and comparable U.S. treasuries. The bigger the gap, the more risky Israel is perceived to be. And it jumped last week, meaning investors are demanding higher interest rates on their loans to Jerusalem. The result will be higher interest rates, and Israel can forget about a sovereign credit rating upgrade for the time being.

3. The budget: The treasury has already announced that plans to cut the defense budget have been deferred from 2007 to 2008. The war and compensation to families, for instance rebuilding homes, will cost money, and trust the defense establishment to translate the outbreak into higher budgets in the future.

4. The shekel: It weakened against the dollar and could weaken more. Read: inflation.

5. Offerings: The primary market has ground to a halt, making it tough for companies to raise money.

6. Oil: All crises in the Middle East cause a spike in oil prices, which dismays investors.

7. The death of the Concept: Apparently, Israel is not quite that safe harbor in the roiling oceans of the emerging markets, after all. We're back to that image of being a little country surrounded by unpredictable hostiles, which is not a good thing for asset prices. Exporters will hurt from this too.

Is there no upside to the conflict?

Theoretically Israel could be made stronger by wiping out the Hezbollah infrastructure and achieving a reasonable security arrangement for the medium-long run. In that case, the sentiment could change dramatically.

How is our economic leadership?

There doesn't seem to be any at the moment, compared with the period of Benjamin Netanyahu. The new finance minister, Avraham Hirchson, isn't pushing with the kind of force that Netanyahu had, and it's palpable. The economy is running on the fumes of Netanyahu's fuel, but unless the reforms are advanced and the finance minister doesn't stop devoting his entire time to politics and survival, we will have a problem.

What should we do with our money?

That depends on your vision of the future. If the war ends quickly the stock market will rebound, possibly quite fast. A prolonged crisis could take us back years.