The IDF’s string of successes in the war with Hezbollah, topped by the killing of the organization’s leader Hassan Nasrallah last Friday night, is the main reason for the sharp rises on the Tel Aviv stock market yesterday, according to Zvi Stepak, founder and chairperson of Meitav Investment House. The Tel Aviv 35 Index rose 1.02% yesterday, after a rise of almost 5% last week, when the series of dramatic strikes against Hezbollah began, although it has fallen back slightly in early trading today.
Talking to “Globes”, what Stepak expresses surprise at is actually the fall in yields on Israeli government bonds, despite the double downgrade of Israel’s credit rating by Moody’s on Friday. Stepak estimates that it will take time before the credit rating is raised again, even if the war in the north ends earlier than we expected.
“The market put Moody’s announcement to one side, but you have to distinguish between the stock market and the bond market,” Stepak says. “In the short term, the impact of the rating downgrade by Moody’s ought to be on the bond market, and indirectly on the stock market.”
What boosted equities, in his view, is “our series of achievements in the war against Hezbollah, including the assassination of Nasrallah. That is much more closely connected to the stock market. From that point of view, I’m not surprised that the stock market rose.”
Why?
“Because the fears that prevailed until a month or two ago, and even going back years, concerning war with Hezbollah, which had stocks of 150,000 missiles and so on, have to a great extent diminished or shrunk. In that sense, as of now, Hezbollah’s capabilities are limited. The fear was of hits to, say, energy infrastructure, and so we are now seeing a sharp rise in oil and gas stocks on the stock exchange. As far as investors and the market are concerned, the likelihood of severe damage to Israel’s economy has fallen.”
What else is affecting the stock market?
“The market estimates that the war will probably be shorter than we thought it would be. That too has implications not just for the stock market, but, in this context, also for the bond market, because if the market estimates that the war will be shorter, then there will be less pressure on the defense budget, on the fiscal deficit, and on the government and so on. So in some sense that contributes to offsetting the dramatic credit rating downgrade by Moody’s at the end of last week.”
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In general, most indices of government bonds have risen, despite the rating downgrade. Does that surprise you?
“The bond market has surprised me. I wouldn’t have been surprised if, say, Moody’s had cut Israel’s rating by one notch and left the rating outlook negative. But they did a double downgrade, by two rungs, and still left the rating outlook negative, so one might have expected to see a rise in yields on Israeli government bonds (a fall in prices).”
Even so, it’s too early to celebrate. “What’s more important is to see what happens around the world (with the opening of trading on Monday) since foreign investors look at things differently,” Stepak says. “As far as we are concerned, an Israeli government bond is a debt that the government will pay us. But foreign investors have their own criteria for the rating at which they invest in various countries and don’t invest in others. It could therefore be that some of them will be nervous (about investing in Israel) because they have investment committees, at pension funds, universities, and so on. There may be pressure there, even if Israel is still rated at an investment grade.
“There is no reason for ETFs that invest in sovereign debt to sell Israeli government bonds, because Israel is still part of the investment grade index. At the moment, they have no reason to sell, unless we fall below investment grade.”
No paradise
Even if war with Hezbollah is turning out not to be as bad as we feared, defense spending is still due to rise. Doesn’t that deter investors?
“There are permanent things that are known and that will be with us in the coming years. Defense spending, buying arms – but there’s also help from the US with its package of grants. Defense expenditure will rise regardless of the war. They talked about a rising defense budget, and it will rise at the expense of civilian services that everyone uses, whether its education services, health, or welfare. Taxes will rise, among them probably VAT. Everything depends on the forthcoming budget.
“In the real economy, it’s not going to be paradise. It will be tough. That could have consequences for companies’ profitability, to revert to the effects on the stock market. But the quicker the war ends, the more it will be possible to cut interest rates. At the moment, the Bank of Israel’s interest rate is stable. If prices of Israeli government bonds fall and our risk premium rises, there is even a scenario, which is not imminent, of a rise in the Bank of Israel’s interest rate.
“But assuming that the war does not continue for much longer, and Iran does not enter the conflict, the economy will face difficult challenges in the coming years, but the interest rate in such a situation will fall. And that will make things easier for businesses, in real estate and elsewhere. In general, a speedy end to the war will not eliminate the need for a higher defense budget, because the need vis-à-vis Iran will remain, but it will make possible moves that will allow the economy to recover gradually. The boom could be in the stock market, not in the real economy.”
When will Israel’s credit rating rise again?
“Moody’s has downgraded the credit rating. The other two agencies haven’t done so yet. Their ratings for Israel are higher. Moody’s justifies the double rating downgrade on two grounds. One is the geopolitical situation, and Moody’s doesn’t know better than anyone else when the war will end. But if the war ends tomorrow, Moody’s loses the basis of its argument, even if it’s true that defense expenditure will still be high.
“The second argument is the problematic conduct of the Ministry of Finance. Moody’s doesn’t believe the ministry’s forecast for this year’s fiscal deficit. They also don’t believe the 4% forecast for the deficit in 2025, and talk about a 6% deficit, and so it depends on how the government behaves.
“That will be the key to the behavior of the market in Israeli government bonds, whether the budget is managed responsibly, and whether a budget can be passed with spending cuts, which is by no means certain. If the government’s conduct from here on is responsible, then the interest rate will be able to fall. If its conduct continues to be problematic – and what is clear from the Moody’s report is that the agency has lost faith in the decision makers at the Ministry of Finance and doesn’t trust them any more – then they won’t hesitate to turn the negative outlook into a downgrade, and then we’ll be in a very problematic scenario.”
What will happen in the event of a further rating downgrade by Moody’s?
“Such a downgrade would be liable to lead to a rise in yields that will push short-term interest rates higher. That’s not a scenario that anyone wants to be in. Even if the war ends within a short time, the next move by Moody’s will not be to upgrade the credit rating. It will probably be to cancel the negative rating outlook and change it to stable. After that, they’ll think about a rating upgrade. They’ll wait for the figures and won’t raise the rating quickly, even if they think it should be raised. They won’t raise the rating at one go, they’ll wait for longer.”
Published by Globes, Israel business news – en.globes.co.il – on September 30, 2024.
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