Israel: Investable Island In Chaotic Seas

With all the upheaval in the Middle East in the past few years, it’s tempting to think the entire region is about to go up in smoke. But don’t count Israel among them—at least not from an investment perspective.

Yes, geopolitical analysts like Robert Kaplan are counseling investors not to hold their breaths in terms of waiting for things to cool down in places like Syria and Iraq, Libya and even Egypt. Truth be told, the list of countries to worry about is a lot longer than those four. You’d be remiss not to throw Israel and Iran onto that list, and probably even Turkey, which finds itself on the edge of so much of the upheaval.

Just listen to those who oppose the whole idea behind nuclear disarmament negotiations with Iran. Deal or no deal, the nuclearized Middle East they say awaits humanity will pose an existential threat not only to Israel, but also to the rest of the Middle East. Even Europe could face nuclear danger, and the world’s policeman, the U.S., will be called on to sweep up the mess.

Troubling possibities, to be sure.

Israel Thriving

But here’s the curious thing: Israel—a country that finds itself in the middle of so much the tension in the region—is somehow thriving in all the uncertainty, leveraging a high-tech economy and its close tie-in with the broader global economy. Just look the chart below that traces returns in the past year for a number of Middle Eastern-focused ETFs.

Chart courtesy of StockCharts.com

The Market Vectors Israel ETF (ISRA | C-26) and the iShares MSCI Israel Capped ETF (EIS | C-56)—in green and black, respectively—are the only funds in the lot that have made investors money. ISRA is a bit more diversified, including non-Israel-based Israeli companies, and limiting the position of any one constiuent to no more than 12.5 percent. Those factors go a long way in explaining ISRA’s outperformance.

And remember, these returns came over precisely the period when ISIS (Islamic State in Iraq and Syria) has surged with the takeover of big cities like Mosul in Iraq, and at a time when oil prices have cratered by more than half due to rising U.S. production and flagging demand from Europe and China.

Meanwhile, the Market Vectors Egypt ETF (EGPT | F-57) and the iShares MSCI Turkey ETF (TUR | B-100) are each about 10 percent lower in the past year, and the iShares MSCI UAE Capped ETF (UAE | F-84) rounds out the losers of the past 12 months with a decline of more than 20 percent.

Developed Vs. Emerging

To a great extent, the divergent returns of the two Israel ETFs with those of other countries in the region are no more complicated than understanding that Israel is a developed country and the others in the Midddle East are not.

To be sure, coming to that place of detached intellectual observation is a bit of a leap of faith. After all, Prime Minister Benjamin Netanyahu’s rhetoric about Israel facing an existential threat from Iran and the fact that Israel is to a great extent surrounded by enemies or quasi-enemies is genuinely unsettling to those on alll sides of the conflicts who dream about a more peaceful world.

But as the chart above suggests, when it comes to Israel, investors probably ought not allow such emotive musings to lead them astray. To start, Israel has quite literally been classified as a developed market by MSCI for the past four years. And rightly so.

It has become the very embodiment of the “knowledge economy” that former Federal Reserve Chairman Alann Greenspan used to crow about all the time as he articulated his vision for the future.

A Huge R&D Lab

Cutting-edge stuff is going on in industry after industry in Israel—from information technology and Internet security firms like CheckPoint, to biotech firms like Teva, to various defense-related technologies to things like drip irrigation technology that will help a world starved for water. Israel has even discovered vast natural gas deposits, bringing the concept of energy exports and energy independencce into the realm of possibilty.

It’s as if—in an economic sense—David has become, or is quickly becoming, a Goliath.

To bring into focus the growing economic separation between Israel and its neighbors, a comparison may be in order.

A world and a few continents away, Chile is considered by some analysts to be “an island off of China,” shipping by air and sea raw materials and things like fine wines to distant trade partners. It’s the vast verticality of the Andes Mountains that makes Chile’s neighbors largely irrelevant to its economy.

In the case of Israel, it’s Israel’s economic and technological sophistication that set it apart from its neighbors and insulates it from the economic fallout of all the strife in the region. The entire economy is almost like a huge research and development laboratory for the whole global economy.

Of course, all that could come crashing down should nuclear weapons ever ruin the party. But as long as Iran doesn’t nuke Israel—which, to my mind, isn’t terribly likely in either the near term or the long term—the Israeli economy and Israel-focused ETFs like ISRA or EIS (and one in the works to be focused on Israeli tech companies) are going to continue to thrive.

To put a slightly cynical twist on the current reality, and to borrow a clever formulation published by Business Week magazine a generation ago, “Israel has everything it needs, except peace.”

At the time this article was written, the author held no positions in the securities mentioned. Contact Olly Ludwig at [email protected] or follow him on Twitter @OllyLudwig.