For the past year Israeli politics has been deadlocked by two indecisive elections and a third one that appears unlikely to end it. The caretaker government is in hibernation and Finance Minister Moshe Kahlon relegated himself to lame-duck status after announcing that he was retiring from politics.
As if that weren’t enough, the budget deficit is growing to what the Bank of Israel says could reach 4.6% of gross domestic product, and in the best case scenario there won’t be a government to address the problem for many months.
Yet on Sunday, the benchmark TA-35 index of the Tel Aviv Stock Exchange closed at 1,725 points, breaking its previous record high set in 2015. The TA-35 index rose 14% in the past year. The shekel is one of the world’s strongest currencies. It rose by more than 6% against the dollar in the same period.
It seems Israeli investors are immune from bearishness. But if they are they aren’t the only ones these days.
“Investors’ greed and their unwillingness to look at the risks is growing all over the world, not just with us,” says Alex Zabezhinsky, chief economist at the Meitav Dash investment house.
“As for the budget deficit, you have to keep it in perspective. While we’ve never before had the experience of three general elections in the space one year, the market believes that a new government will take the steps needed to deal with the deficit.”
What could turn the market bearish? “If the political freeze continues, than economic growth is expected to be seriously hurt. The uncertainty will undermine the economy and it will take the financial markets down, too,” Zabezhinsky says.
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Right now, however, investors aren’t assigning a high probability to thatworst-case scenario happening. Perhaps due to the fact that anyone who had bet against the market over the last year would have lost out on big returns.
“Even if there remains a risk, it hasn’t expressed itself concretely in the market – greed has been more powerful than fear,” says Zabezhinsky.
Michael Sarel, the head of the Kohelet Policy Forum’s economic forum and a former Finance Ministry chief economist, is less sanguine about the budget deficit.
“The deficit is a serious problem. Not in the sense of bankruptcy or insolvency but in a future sense of crisis and the danger that Israel will have to take austerity measures and increase taxes during a recession. That would hurt ordinary people and could cause social tension,” Sarel says.
Right now, however, Israel’s economy is in good shape, says Zabezhinsky. Among Organization for Economic Cooperation and Development member states, only Ireland had a faster rate of growth in 2019. Israel’s GDP rose a preliminary 3.3% last year and government forecasts for this year see only a slight slowdown, to 2.9%-3%.
Sarel says the markets are less concerned with economic growth than they are with inflation and interest rates, but those are also favorable. There’s no sign that either is going to take a turn for the worse.
“That forecast gives a lot of tailwind to [market] indexes. While the government isn’t doing anything to encourage economic growth, Israel isn’t in a crisis situation or recession,” Sarel says. “The local market is influenced by world markets where inflation is low and the forecast is that interest rates will remain low over time. Investors also lowered the risk of a major U.S.-China crisis.”
Even if the deficit isn’t a crisis, the absence of a permanent government has a direct impact on the many companies that rely heavily on government contracts. Many contracts that were put up for bids haven’t been awarded and no new ones have been issued.
Tiran Rothman, the head of the consulting firm Frost & Sullivan Israel, said his firm had bid on a Transportation Ministry contract in June that was supposed to have been awarded by September. To date, the bidders have heard nothing.
“In another request for proposals issued by the Energy Ministry, we decided to drop out because it was taking too much of our resources and they kept delaying it,” says Rothman. “It’s created a logjam.”
“Because of the political uncertainty, companies like ours that invested resources and personnel on tenders have absorbed losses. All the investment went into the trash,” he says.
Nevertheless, Rothman doesn’t see that as a problem big enough to discourage market bulls.
“Even in our current economic situation, many European countries would gladly trade places with us, so there’s no need to worry too much. The stock market can keep rising for the next few years. There’s no connection to the highs it’s already conquered. It will fall in line with the U.S. stock market.”
On Wall Street, the benchmark S&P 500 stock index registered a record high close on January 17.
Mati Gil, head of government affairs, corporate and international markets at Teva Pharmaceutical Industries, is a bit more worried. He says that international investors weighing their position in the Israeli stock market are perplexed by the extended government crisis.
“They ask us, what is going to be the government’s policies in three to five years so they can prepare. I don’t know what to tell them,” he says.
“The attractiveness of the Israeli market of multinational companies has been hurt, For instance, pharmaceutical companies that are developing their investment programs going forward are more likely to prefer to market their drugs in another country and not in Israel, so Israel falls lower ion their priority list,” Gil warned.
Erez Wilf, the head of provident and pension fund investments at investment house Altshuler Shaham, is more optimistic on that account. Despite the deficit, the Israeli economy is strong relative to other countries and that has supported a strong shekels.
“Israel has become an alternative to foreign investors, venture capital funds, that invest in startups, invested more than $8 billion in Israel just in 2019,” he notes. The reason is that in an era of global low interest rates, alternative investments such as startups have become more popular.
“Foreign investment coming into Israel weakens the dollar and other foreign currencies versus the shekel, and that’s why the currency is so strong,” says Wilf.
If the Bank of Israel hadn’t intervened in the current market – as it did again Thursday, to almost no avail – Wilf said the shekel would be trading at 3 to the dollar, not the 3.46 at which it Tuesday.
“In the past two years we’ve seen a widening budget deficit. The next government will have to take serious steps, cutting budgets and raising taxes. That will affect the average citizen and economic growth,” Wilf says.
But, he adds on a hopeful note, these days the Israeli government could borrow at much lower rates of interest, Three years ago it issued 10-year debt at 2.5% interest; today it has raised money at 0.5%. “That’s a savings of hundreds of millions of shekels on current interest payments that can be directed instead toward investment in areas where we have serious problems, like health and education.”