Taking Stock / Joe's Story

He's 33 years old. He has worked on Wall Street for 12 years and today runs an American hedge fund, one of many that has raised hundreds of millions of dollars around the world in recent years. He has never visited Israel. Until last Wednesday, that is, when he landed at Ben-Gurion, got into a cab and rode to the offices of one of the bigger investment banks in Tel Aviv.

There's only one thing that, let's call him Joe, cares about: whether Shahar bonds are still a good buy.

Meet the new foreign investor in Israel. He couldn't care less about Israeli high-tech, or our scientists, or our inventions. He doesn't import or export; he isn't trying to sell us anything; and, in fact, shows no particular interest in current events here. He is entirely focused on whether Israeli government debt, traded in the form of bonds on the TASE, is a worthy investment.

A not-so-long list of people like Joe, who run investment portfolios, hedge funds or the proprietary investment portfolios of major banks, are the hands that have lifted up Israeli government bonds so drastically in the last six months, and have brought the dollar so low against the shekel. They generated the wave of gains that has induced the central bank to lower interest rates, and that stands behind much of the positive sentiment sweeping financial markets lately.

True, the sums invested here are not vast - maybe half a billion or $600 million. Not much by the terms of Israel's bond and currency markets. But it certainly points out a direction to local investors, who jumped on the bandwagon and sold foreign currency and bought bonds too.

What brought Joe over here? The treasury's economic program? Netanyahu's photo op with Alan Greenspan? Not exactly.

Saddam who?

Joe streamed hundreds of millions into the Israeli marketplace back in late January, when Israel was occupied with elections and the United States was busily preparing to invade Iraq.

Joe's interest in Israel was not piqued by the much-vaunted geopolitical changes in the region. The attraction for him and his ilk was the rapid drop in American and euro-bloc interest rates in the last couple of years.

Our investor and his friends have been prowling with rumbling bellies for a year now. The rates offered by western markets shrank and shrank, then almost vanished entirely six months ago. Real interest rates in the West are approaching zero at best, or less at worst.

In fact, real interest rates in the West have been bottom-crawling for more than a year now; it's just that six months back, something else happened. Joe & Co. realized that the situation could last a long, long time. Central bankers were starting to hint that major economies could be entering a long period of deflation, which would force them to maintain very low interest rates .

That was the moment when Joe et al started to globe-trot, looking for riskier investments offering fatter interest. And thus hundreds of millions were thrown at all sorts of bonds. The result was palpable wherever you looked - the spread between American T-bills and riskier bonds issued by corporations or governments of emerging markets, the spread that embodies the risk factor, dropped by dozens of percent.

Yeah, sure Bush will win

Joe and the Israeli capital market had crossed paths before, in the late 1990s. But then he tossed a few peanuts into stocks, and didn't even consider investing in Israeli government bonds. The interest rate spread back then was relatively minor, and negotiability was negligible.

Yet as America rattled its sabers at Iraq, Joe returned his attention to the Israeli marketplace. He figured that the United States would thrash Iraq, that the risk associated with the Middle East would ebb, and that Israeli government bonds bearing interest of 12 percent - while inflation was crawling at around 2 percent - looked mighty attractive.

After a few phone calls to his investment bankers, Joe discovered something else, maybe the most important of all. Back in the late `90s, most Israeli T-bills were linked to the consumer price index, and were sold in unending series of non-negotiable notes. But today's bond market is unlinked, big and liquid.

Liquidity was key. Joe issued his first order.

Betting on shekel bills

He didn't think matters would develop quite that fast. The United States invaded and then announced loan guarantees for Israel, the Israeli treasury's economic program began to pick up momentum, and finally - unbelievably enough - the prime minister started to mention withdrawal from territories and ending the occupation.

Bond prices shot up, the local banks snapped up more bonds for their own portfolios, yields sank below 10 percent, conversion of dollars into shekels depressed the greenback, and Israelis, who had been sitting on dollars, began to lose their nerve. They also started to sell. In dollar terms, Joe's profit from his bet on shekel bills leaped gaily past 10 percent on medium-range series, and jumped beyond 20 percent on the long-term notes.

Naturally, Israel was only one of his picks. Joe also streamed tens of millions of dollars into bonds issued by Indonesia, Mexico, Brazil. He dabbled in Turkish paper, too, where the interest rates are sky-high, but so is the risk. Turkey, if you remember, did not "behave itself" in the war with Iraq, so it didn't get American loan guarantees, and is now struggling under the weight of huge debt and raging inflation.

Does Joe believe in Sharon's peace process? No, he has no clue what Sharon and Abu Mazen are about. He just figures Bush will remain deeply involved until the next U.S. elections, and that Israel enjoys an unflagging American shoulder. "All the senators I met recently were confident you would get the guarantees," he says.

Does he like Netanyahu's economic plan? Was he impressed by the finance minister's road show the last couple weeks? No, he knows the difference between smoke and fire, he differentiates between show and reality. Certain elements smack of serious intentions, such as the public sector wage cuts and the pension reform, he suggests, but there's a lot of hot air and exaggeration in the presentation of the things Bibi achieved.

He giggles at Netanyahu's comment that analysts at one of the rating agencies said they hadn't seen an economic reform like Israel's in any of the 90 countries they cover. "Where exactly did that appear in their report," he snickers.

Joe also understands perfectly well that the government is going to run a massive deficit this year, and that next year isn't looking rosy, either. He has read studies by Israeli analysts, describing the irresponsibility of Israel's fiscal policy over the years, how it frittered away the fruits of the boom times, and how much trouble it's having imposing structural reforms.

But in the short run, maybe the medium run too, he doesn't see the danger of a financial crisis in Israel. He even thinks there's a good chance the economy will recover. His arrival attests to the fact that he believes there's meat in this here market. Interest on long-term Shahar bonds has dropped from 11 percent to 8 percent and could sag another 1 percent in the months to come. That would mean that prices could jump another 10 percent, or 8 times the return on U.S. T-bills.

"In short," he tells us, "there's a good story here. We made a lot of money here, and we don't care about the long run. In the short run, there's an opportunity to make more money, mainly given the fact that more guys like me could come in."

It was late. We agreed to talk again, but by the next afternoon he was on his way to the airport. Right, we almost forgot - Joe is a fast operator. He doesn't have time to shoot the breeze, he was flying to London.

We should all keep firmly in mind that these guys can disappear even faster than they appeared.