Taking Stock / One, Two, Three, Jump!

You blinked. You looked away for a second. You just vowed never to touch stocks ever again - and whoops! The market jumped 50 percent.

It did, too. The broad index of shares has risen 50 percent from the start of 2003, in real terms. The Tel-Tech-15 index, which includes the 15 biggest technology shares listed for trade in Tel Aviv, has risen 117 percent.

Despite the Israeli penchant for treating the stock market like a casino for lunatics, we cannot ignore an increase that sharp and fast. And history shows that share prices on the TASE often serve as a pricing basis for major transactions in companies traded on the exchange, or even in takeovers of privately held companies.

On the background of the prevailing economic uncertainties and contradictory opinions regarding the third-quarter growth data, let us try to look at the reasons behind the dramatic upswing on the stock market.

Let's begin with the bottom line. Despite the preliminary data showing 2.7 percent GDP growth in the third quarter, it cannot be said that economic activity has turned around yet. Most of the big companies listed on the TASE, that operate in the domestic arena, continue to feel the recession. Revenues are stagnating and sales prices are crumbling. The stock market may assume we've reached rock-bottom in the contraction of real economic activity, but we can hardly start prating about a return to significant rates of growth just yet. So what sent stocks climbing like that?

The guarantees. The U.S.'s decision to extend $9 billion cheap, long-term credit to Israel changed the face of the bond market from top to bottom. Each dollar Israel raises abroad, by virtue of the loan guarantees, is a dollar less it needs to raise through the local bond market.

The dramatic change in the government's previous utter reliance on the domestic bond market is the main engine driving local bond prices higher. It is also the reason long-term interest rates have been dropping. The drop in long-term rates and reduced supply of government bonds release resources for the business sector and greatly stimulate the appetite for the risk built into shares.

The risk. America's invasion of Iraq, the loan guarantees and the change of reign at the Finance Ministry lowered Israel's risk premium. Share prices at the start of 2003 reflected a high risk of economic crisis. When the risk dropped a notch, share prices rose a notch.

The drop in short term interest rates. After misguidedly slashing interest by 2 percent in December 2001, the Bank of Israel was forced to raise the real short term rates it controls to record heights in 2002. The Finance Ministry's fiscal irresponsibility at the time turned high interest rates into the only pillar of stability around.

After a year of high real interest rates, and after the U.S. decided to give Israel the guarantees, the financial and currency markets calmed down, as did inflation expectations. That calmness coupled with the oppressive recession enabled the Bank of Israel to resume lowering interest rates, to record low levels. With bank deposits offering 2 percent to 3 percent, the general public is starting to look for alternative investment vehicles. The result is that a lot of the money the mutual funds raise gets routed to investment in shares.

Nasdaq. Yes, it's back, and howling. After two years of massive stable-cleaning and crisis, Americans are buying tech stocks again, and not only are they buying stocks, but they're buying ones that gave them a lot of grief.

If low interest rates are making Israeli investors antsy, then for Americans, the situation is far more severe. For a year now, risk-free short-term interest has been touching on zero. More and more investors are being drawn back to stocks.

The Nasdaq's 40 percent-plus gain has had terrific influence on the Tel Aviv indices. Firstly, dual-listed shares, traded on Wall Street and locally as well, have risen strongly. Stocks like Scitex Corporation (Nasdaq:SCIX), Alvarion (Nasdaq:ALVR), AudioCodes (Nasdaq:AUDC) and Metalink (Nasdaq:MTLK.O) have seen their stock rise 200 percent to 400 percent this year.

Nasdaq is also influencing matters through holding companies listed on the TASE. Koor Industries (NYSE:KOR) stock has risen 220 percent after its affiliated company, ECI Telecom (Nasdaq:ECIL), shot up on Wall Street. ECI is still losing money hand over fist, and nobody can say when it will see the black again. But the mood in the telecoms market and on Nasdaq has turned around and ECI stock has risen 200 percent this year.

The third influence is through sentiment. When Wall Street is booming and multiples are doubling, Tel Aviv's investors can't sit around dawdling. Granted, the U.S. economy is growing fast while Israel's is stagnating at best, but the stock market is not concerned about that.

Exporters. Domestic demand remains low and prices are depressed, but exports picked up this year. Several of the more successful exporters are listed for trade on the TASE, companies like Makhteshim Agan Industries (TASE:MAIN), Teva Pharmaceuticals (TASE, Nasdaq:TEVA) and Agis Industries (TASE:AGIS). Each has its own growth story, which has nothing to do with Israel's story.

Cleaning up acts. Most of Israel's companies have spent the last couple of years cleaning up, cleaning out, cutting back and mainly adapting their business models to the hard times. Even the laggards began making moves during 2003, recording the charges and cutting the costs they should have done all along. Acknowledging reality is the first step toward economic recovery.

IPOs. The growing demand for risky shares and assets hasn't been met yet with major supply of shares and bonds on the primary market, resulting in soaring prices.

That situation faces rapid correction. There isn't a businessman in Israel who isn't polishing a prospectus to raise money through issuing bonds or shares. The public's appetite for securities is just starting to awaken, but business is ravening for cash.