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Merrill Lynch on Wednesday joined a growing list of investment firm reiterating their confidence in the Israeli market despite ongoing violence in the North. Nevertheless, the broker maintained its "underweight" rating on the market and advised investors to play it safe for now by focusing on companies that have limited exposure to the country.
"For now, at least, we believe that Israel's market fundamentals remain intact and should not be overlooked," analyst Haim Israel wrote in a research note. "While a short-term conflict creates fertile ground for profit-taking, long-term military engagement would lead to a very fragile market, prompting investors to see opportunities elsewhere."
Since for the moment it was impossible to say how the current conflict would turn out, Israel recommended investors to opt for the safe havens as valuations fall.
"Although some shares have fallen to very attractive valuations, such as the banks or telecom companies, we would recommend to play it safe and concentrate on multinational names with limited or no exposure to Israel, as well as specific domestic names that can leverage the situation to boost performance," the analyst told clients.
Israel's recommended stocks are export-oriented companies with limited exposure to the Israeli market such as Israel Chemicals Ltd., Ormat Industries and Teva Pharmaceuticals.
On the domestic side, companies such as Partner Communications, which historically benefits from stronger volumes in a tense security situation, are also on Israel's list of stock picks.
Evaluating the impact of the war on Israeli hi-tech companies, Merrill noted that only in a doomsday scenario of all-out war would most companies be substantially impacted, leading to disruption of operations.
"Most Israeli tech companies have their R&D, management and other operating functions in Israel, while most tech employees are young below the age of 44 and would therefore be called to active military duty should the war escalate," the broker said. "Most of these companies are based in the center of the country so if longer-range missiles put Tel Aviv and central Israel at risk, it may disrupt the operations of most of these companies."
Analysts at Morgan Stanley, meanwhile, described the latest eruption of violence in Lebanon and Gaza as "another twist in the endless cycles of shocks in the Middle East."
The investment house agreed with other global analysts that economic implications of the conflict were dependent on how long it would last and how bad it would get.
"The escalation of hostilities may lead to a slowdown in the Israeli economy through a reduction of tourist arrivals, a withdrawal of foreign portfolio investments and a drop in domestic demand," said Morgan Stanley's Serhan Cevik.
Economists at Bank Leumi said in their weekly report that although it was hard to determine the economic implications of the escalation because of uncertainty over the length and extent of the conflict, it was clear to date that economic activity in the North had been hard hit.
As a result of the changed circumstances Bank Leumi slightly lowered its growth forecast for 2006 gross domestic product from 4.7 percent to 4.5%. It added, however, that even before its forecast relatively low compared with the majority of outlooks for growth of over 5%. The revised forecast is based on the assumption that the conflict will not last very long and that there will be a swift recovery.
Morgan Stanley expressed confidence that the outburst of violence was unlikely to trigger a conventional war because of Israel's military superiority and economic stamina.
"Israel's military might alone cannot bring peace and keep economic expansion on track unless one of the most important root causes of all these hostilities - the Palestinian crisis - is resolved," Cevik concluded.