SUMMARY
- Israeli equities again delivered a positive return in September, despite a volatile start to the month when share markets initially fell upon fears of a slowdown in the global economy.
- The local equity market performed well despite growing tensions on the border with Lebanon, rising domestic inflation, and downgrades in the credit rating of Israel’s government debt.
- The Fund returned +1.9% (Class A, AUD) and +1.7% (Class B, USD), while the TA 125 Index returned +1.8% in September.
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COMMENTARY
Market Review
Israeli equities delivered a positive return in September in what proved to be a volatile period for investors. The local market initially moved lower as global equities fell upon signs that the global economy was slowing faster than had been expected and the US economy reported fewer new jobs being created.
However, Israel’s share market bounced back later in the month after the Federal Reserve cut US interest rates by 0.50%, with the European Central Bank also easing monetary policy. The local market was particularly supported by the ongoing strength of its technology sector.
Inflation in Israel increased unexpectedly to 3.6% year-on-year in August from the previous month’s 3.2%. This was driven by services inflation accelerating to 3.8%. The Bank of Israel’s inflation forecast for the next 12 months remains at 3.1%.
The Bank is expected to leave interest rates unchanged at 4.50% despite inflation rising above its 1.0% – 3.0% inflation target range. Were it not for falling interest rates in North America and Europe, an increase in interest rates would likely be seriously considered by the Bank.
Composite State of the Economy index data showed that the domestic economy resumed its expansion over the northern hemisphere summer months. This was supported by stronger services exports, led by the technology sector.
The Bank of Israel reported that its foreign exchange reserves had grown to a new all-time high of US$220.4 billion by end-September. This represents 42.8% of Israeli GDP, which is an exceptionally high level by global standards and provides support to the currency during periods of instability.
September saw rising tension on the country’s northern border as rocket attacks by Hezbollah on Israel intensified, leading to growing expectations of an Israeli ground intervention in Southern Lebanon. Israel approached the first anniversary of the 7 October terrorist attacks in the south of the country in sombre mood, but having demonstrated a high level of resilience. This is reflected in the strength of its economy and especially its technology sector.
The deteriorating security situation led to downgrades in Israel’s sovereign debt by credit rating agencies S&P (one notch from A+ to A with a negative outlook) and Moody’s (two notches from A2 to Baa1). This reflects the agencies’ expectations of a long-term increase in defence spending and little sign of an early end to the conflict. However, S&P highlighted Israel’s economic strength, stable trade balance and history of rebounding quickly from conflicts.
While the downgrades may be negative for investor sentiment, we do not believe they reflect the resilience of Israel’s economy or the ongoing level of economic activity. This was evidenced by several developments during September:
Portfolio Commentary
The Fund continues to take a positive view of Israel’s economic and share market prospects, despite the ongoing geo-political uncertainty. The Fund’s net equity exposure remained at approximately 85% in September.
The largest contributor to the Fund’s relative return in September was its overweight exposure to the financial sector, with banks rising a further 5%. Holdings in the Tel Aviv Stock Exchange, fintech platform Nayax and industrial group Inrom also contributed to relative returns.
The largest detractor from relative returns in September was the Fund’s holding in the printed circuit board manufacturing company Priortech. The stock underperformed, falling 13% upon continued weakness in the global semiconductor sector. The Fund took the opportunity to increase its exposure from 4% to 5% at an attractive valuation level.
The Fund established a new position in Silcom, which produces components for server farms and communications networks. The stock underperformed when the post-pandemic period of re-stocking began to unwind, falling by 70%, as new orders were cancelled or postponed in light of elevated inventory levels. This fall in sales is likely to prove temporary and its strong balance sheet makes its current market valuation highly attractive.
The Fund took advantage of the rally in the banking sector to reduce its exposure to Bank Leumi and Bank Hapoalim during the month.
The Fund maintains its overweight position in real estate developer and manager Azrieli Group. It has built a very attractive data centre business through a series of acquisitions in North America and Europe, with further deals under negotiation.