October 1997

Israel, an outlook – Rotating stocks into small and mid caps.

Israel, an outlook

Since the election of the Benjamin Netanyahu coalition into government the situation in the Middle-East has changed dramatically. Not only the political landscape changed but also the economical and social situation turned into misery.

Netanyahu promised in his election tour peace with security but the reality brought, ones he was in power, insecurity without peace. The peace process has been put on ice. The Israeli government considered the needed action to sustain the peace process as a danger to the security of Israel. It restarted the building and enlargement of settlements on the West Bank, it demolished houses of Palestinians which were allegedly illegal and it did to a certain extent destroyed the economical buildup of the Palestinian entity.

The Netanyahu government could not stop the suicide bombings which happened every time the peace process seemed to get going again. Netanyahu accused the Palestinians for not doing enough to destroy the terrorist organisations of Hamas and Jihad. The Palestinian authorities are however not competent and lack the intelligence organisation to combat those organisations. A further problem with the terrorist organisations is their cell structure which makes eliminating them very difficult. And the Hamas is not only active with violence against innocent civilians but it also has a very large humanitarian organisation. It supports schools, medical centers and poor people. By destroying this part of Hamas would mean an end to the Arafat government in the Palestinian entity. Especially if Arafat is not able to replace the services of the Hamas humanitarian organisation.

The political change

The internal situation in Israel is no more stable than during the previous government, probably even less secure. A large number of people are dissatisfied with the situation. The Israelis because the terrorist organisations continue with their “senseless” bombings and the Palestinians because their chance for an “independent state” is getting very unlikely.

Netanyahu seems to get away with his confrontational policies which supposed to bring more security to Israel while at the same time keep as much influence and territory as possible. The opposition in the Knesset but also the people on the street can not stop nor change the policy of Netanyahu.

The international community disapproves this policy but without backing this disapprovement with any sanctions. And as long as Israel is supported by the U.S.A. it does not have to care to much about the feelings abroad.

This policy will however deliver no security on the long term, it is even doubtful if it can guarantee any security on the short term. All the actions of the Israeli forces in Israel, the West Bank, Gaza and even in Lebanon proved to be very ineffective and expensive in terms of human lives.

The external postion is even as bad. The security zone in Lebanon is becoming more and more a killing field for Israeli soldiers. Even the most elite of the IDF, Israeli Defence Forces, get massacred in Lebanon by a reinvigorated Islamic resistance of the Hezbollah, Amal and even the Lebanese army.

The relations with the Arab neighbours seems to deteriorate with the day. Only Jordan tries to save the peace process. There are even rising tensions with Syria who is accused by some Israeli military officers of preparing a war against Israel to regain the Golan.

The internal and external position of Israel is undermined by the one-sided approach of Netanyahu who promised peace with security but delivered insecurity without peace.

The social and economical situation

Since the election of Netanyahu and freezing of the peace process the economy has turned bad. The growth has returned to low levels, the state expenditures are not inline with the diminishing tax returns and the unemployment is rising again. The peace process was the stimulant of an incredible economic growth in Israel. But the harsh policies of Netanyahu destroyed the confidence of foreign investors, hampered the export of Israeli products and even reduced the consumer demand in Israel.

The weak Israelian economy and the even worser if not to say disatrous economy of the Palestinian entity could be the seed of even more instability in the future. In this situation there easily starts a reinforcing spiral of social misery which leads to a greater attractiveness of extreme religious organisations in Israel, Gaza and the West Bank.

The fundamentalistic groups in both territories are already becoming more powerfull because of a growing membership and especially in Israel because of the important role they play in the coalition government.

The deteriorating economy will reinforce their influence in the society. This will eventually increase the contradiction between the two opposed groups, Judaism and Islamism. Between those two fundamentalistic groupings peace will be impossible and a disaster only a matter of time.

The Israel – Palestine relation

If we consider the difficulties described above it will be absolutely necessary to give the peace process which started in Oslo another chance. The two important parties, the governments of Israel and the Palestinian entity, have to come together again and start talking to implement the Oslo accords.

To get peace with security sacrifices are necessary by both parties. The Israeli goverment has to grant the Palestinian entity the means to build a viable economy in their own territory. By this way Arafat will be in the position to eliminate the humanitarian part of the Hamas and eventually will also be able, with Israeli training and suppport, to eliminate the armed wings of the Islamic terrorist organisations.

The Palestinian authorities in cooperation with Israeli security services should do their best to minimise the influence and actions of the several terrorist organisations. They should do this not only if there is heavy pressure from Israel and the U.S. but make it a part of their policy. If a thorough plan is carefully executed the terrorists will have difficult job to survive.

In the mean time total security will not be possible for Israel but if the peace process will be fully implemented the terrorist threat can be minimised. This together with an economical recovery of Israel and the Palestinian entity will be the only possibility for a lasting peace. The Arabs and the Israelis will not become friends but in this way they can live together. That is a mighty advance on the hostility from this year.

Rotating stocks into small and mid caps

The New York stock exchange showed its volatile behaviour in the last month. The blue chips of the Dow went down and up where as the Russell 2000 seemed to outperform all expectations.

We remain however positive about the future of the blue chips. Therefore we maintain our buy rating on the stocks we listed in our last report. We envisage a continuation of the volatility but at the end of the year we expect the Dow Jones Industrials at around 8.200 maybe 8.400. The large caps, the multi-national companies, with a low P/E rating and an attractive product package and export potential still offers some very good chances to make a more than average return.

The small and mid cap stocks will also see some impresssive growth on the short term. They might even outperform the big caps on the short term. The booming American economy will be a guarantee for the performance of the Russell 2000.

We like the following mid and small cap companies. They will most probably show a better performance than their counterparts. In the defence sector we like Tracor, Stanford Telecom, Viasat and Orbital Sciences. In the transport sector we expect a lot from US freightways, Comair and Atlantic Coast Airlines. Further we like companies like Method, Vesta, Swiss International, HS Resources, Coach USA, Baker Fabric, Analog Devices and Measurement Specialties.

All these stocks could be an interesting investment but we prefer the larger international companies because they offer a better potential on the long term and that is the game we like most.