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Merrill Lynch continued to recommend a "neutral" rating on Israeli markets Thursday, citing concerns about liquidity, which the broker believes will remain under pressure this year.
"Given the expected decline in global emerging market returns in 2006, the moderation in international flows and pressure on domestic liquidity, we believe investors should be more defensive," analyst Haim Israel wrote in a research note.
Meanwhile, in the wake of Kadima's weak showing in Tuesday's elections, Israel said he expects a weaker fiscal stance and a slowdown in the pace of privatization because most of the likely coalition partners advocate a more generous welfare and higher minimum wages.
"In our view, there will be no difficulty in forming a majority government," Israel said. "However, a four- or five-party coalition government may prove unstable in the medium-term."
The analyst added that he was keeping a watchful eye on political developments and said he expects the 2006 national budget will be approved in June, retaining the 2005 budget framework and 2.5% to 3% budget deficit target.
Israel noted that the main driver of the Israeli market in 2005 was global and domestic liquidity. Yet, despite massive inflows of global liquidity into emerging markets, most were into other markets so Israel did not enjoy the full benefits of the emerging markets rally.
He believes global emerging market fund managers are underweight Israel because the MSCI Israel index acts defensively in terms of the global growth cycle because its composition continues to be dominated by Teva Pharmaceutical Industries Ltd. Expensive technology valuation relative to other sectors in emerging markets is also a factor Israel thinks is keeping investors underweight in Israeli stocks.
"We continue to believe that tech valuations remain expensive compared with other sectors in emerging markets, a reason to avoid those particular stocks," he said.
To hedge against political shake-ups and uncertainty surrounding the peace process, Israel increased the weighing of multinational names in the firm's Israeli portfolio, while recommending limited exposure to domestic names.
"We are still recommending Israel Chemicals and also favor increasing exposure to Teva to weather the increase in US rates and decline in global GDP growth," Israel told clients.
He also added Ormat Industries to the broker's recommended list, calling it an undervalued name and a hedge against global energy prices, and he highlighted Bezeq as his recommended restructuring/dividend play, saying it was the preferred way of playing the consumer spending and private consumption trend.