As the Conflict Escalates, the Stock Market Slides

Why is the stock market sliding?

Because in many respects, the war harms the Israeli economy, and of course also the companies traded on the bourse.

Except that yesterday, the stock market rose.

Large fluctuations are typical in a crisis period, as are reports and rumors that affect the strength of the bourse. New positive information boosts the stock market and negative information drags it down. All in all, the war caused shareholders tens of millions of shekels of damage.

Until now, everyone, including TheMarker, has been recommending Israeli shares. Can a few days of Katyushas do so much damage?

We truly believe that the Israeli economy has been demonstrating impressive performance and the financial data are excellent. These are also the things that have fueled the bourse's upward momentum in recent years. Still, the war in the north inserts new and surprising information into the equation.

Share prices, like those of bonds and the shekel/foreign currency exchange rate, are set by past performance and the current situation, and perhaps mainly based on future expectations. The bourse responds to new information and updates its expectations accordingly, and the war dampens, or at least clouds, all the rosy expectations.

What economic damage is the war causing?

The total scope of the damage is still unclear, as two major factors are missing - how and when it will end. This uncertainty is also one of the reasons for the bourse's instability. Investors estimate the price of the risks of extended fighting and the entry of Iran and Syria, for example.

Still, the real damage is mentioned in terms of only a few tens of millions of shekels. That alone should not topple the bourse.

This however, is only the direct damage. The indirect damage is far greater. Most of the residents of the north, from Tiberias northward, are involved in the tourism industry that has been developing in leaps and bounds in recent years. At this point, it appears that the current tourism season, due to peak in the coming weeks, is already over.

More than tourism at stake

Everyone says that tourism constitutes a very small portion of Israel's business product.

True, but more than tourism is at stake here. Real estate and even the stock exchange have flourished in the past two years thanks to the massive influx of foreign investors. Although the mammoth deal in which Warren Buffet purchased 80 percent of Iscar for $4 million has been completed, the monthly $150 million that infused Israeli apartment market is liable to stop flowing, seriously harming the real estate market.

What other negative influences can affect the economy?

1. Private consumption. The public's sense of wealth has been upset by the declines on the bourse and the feeling of security has been undermined by the rockets. Both of these factors could slow private consumption, which has been one of Israel's strongest growth engines in the past two years. The bustling malls and the thriving entertainment spots are liable to suffer. Such things are both emotional and psychological matters. Pessimistic people glued to the news broadcasts do not go out to restaurants and night clubs.

2. The risk premiums. Israel's risk premium is a professional term expressed by the difference in the yield on Israel's government bonds and those issued by the United States treasury. The larger the difference, the greater the risk to the Israeli economy.

By the end of last week this premium had already risen, meaning that investors were willing to lend the Israeli government money (by buying government bonds), at a higher rate of interest than before the war.

This interest rate immediately affects the private business sector, as its level of risk is dependent on that of the state. Israel's international credit rating will also have to wait for better times before it is upgraded.

3. The budget. The treasury has already announced the cancellation of the planned trimming of the defense budget and there will be additional war expenses - from the compensation to businesses and families that have been hurt, to the renovation of damaged buildings and infrastructure and the cost of increased reserve duty.

4. Depreciation. The shekel has weakened against the dollar since the war began. Additional weakening will affect inflation.

5. The halting of new stock issues.

6. The rise in the price of oil. This happens in every serious Middle East crisis, and the current situation is no exception.

7. The collapse of the conception that Israel is a "safe haven in the stormy sea of emerging markets," as she tries to portray herself to the world. An unstable image of Israel will affect exports, as European customers, for example, will think twice before placing orders with Israeli manufacturers.

Can anything good come out of the current hostilities?

Yes. If Israel retains the upper hand and destroys the Hezbollah infrastructure, followed by a reasonable political-security arrangement, there are good chances the atmosphere will change immediately.