The assault on Middle East stocks has been two-pronged with the global equity rout and lifting of Iranian sanctions weighing heavily on sentiment throughout the region. The Tel Aviv 25 (TA-25), which was among the better performing instruments compared to global indices in 2015, has gotten off to a rough start in 2016 as concerns about the pace of global trade combined with a potential rising threat in the east threaten to derail a four year bull market in Israeli equities. However, accommodative monetary conditions, a weakening shekel and rising exports especially in the technology space might be enough to see the TA-25 outperform other global benchmarks over the medium-term as external conditions deteriorate further.

Global Exposure

The startup nation hosts an incredibly diverse economy, evident by the composition of the Tel Aviv 25 equity index which is comprised of Israel’s largest blue chip stocks. Although the economy is relatively insular considering its geographic disposition and limited trade with neighboring countries, the reach of the nation is global, especially with rising exports and growing emphasis on emerging markets in the east like China and India. A focus on worldwide diversification and influence on technology that has become a part of nearly every mobile device has made the region indispensable from a trade perspective.

In many ways, this very exposure to economies around the world and lack of dependence on a single marketplace will help local companies weather the storm brewing in Asia. Strong trade relations with Europe and North America may help to offset the decelerating growth in eastern markets to a degree, and in general the local economy remains a robust source of demand for listed companies. Most importantly however remains the ability to innovate, a core tenant of the nation’s appeal to international investors. Nevertheless, the potential for the security situation to worsen on the heels of the lifting of Iranian sanctions has weighed heavily on sentiment as evidenced by the selloff that transpired immediately after.

Local Impact

Highly accommodative monetary policy measures have made the TA-25 very attractive from a number of angles. With interest rates near zero at 0.10%, the Shekel has been able to weaken substantially against the dollar, helping to buoy export competitiveness at a sensitive moment in time for global trade. The domestic economy remains relatively robust despite the fact that it is firmly in deflationary territory, meaning the Bank of Israel will be unable to liftoff from zero in the near future because of the risk of accelerated deflation, keeping the shekel weak at least over the medium-term.

The weaker shekel and continued depreciation means that on a relative value basis, the TA-25 becomes cheaper in comparison to other globally traded equities, increasing the appeal for investors. On a valuation basis, the current price-to-earnings multiple below 16 implies that the index is not so overvalued, but does mean that the index might not be bargain at current rates. However, for investors looking to assemble a long-short equity portfolio of outperformers and underperformers, the -4.24% year-to-date performance is certainly outstanding taking into context the pace of the global equity selloff.

Technically Speaking

While the TA-25 index will benefit from the tailwinds of the valuation and falling Shekel, pretending that the equity benchmark will be impervious to global forces is undeniably short-sighted. While geographic diversification might be helpful in the good times, it raises the risk during the bad times. After peaking back in August, the TA-25 has steadily been on the decline, with the swift correction added evidence of the deeper pullback underway. Although the index has not yet fallen into bear market territory which begins at 1383, the current downtrend is likely to prove unrelenting, delivering the index to the bears in the coming sessions.

(Click on image to enlarge)

Adding to the bearish case for the Tel Aviv 25 is the moving averages, with both the medium-term 50-day moving average and longer-term 200-day moving average both trending lower. More importantly is the crossover that occurred back in October with the 50-day crossing the 200-day to the downside, indicative of the emergence of the “death cross” technical pattern which typically results in heightened downward momentum. After reaching oversold territory late in the week, willing sellers should not be too eager to take additional short positions in the TA-25 until prices rebound further, especially with the relative strength index trending towards the middle of the range.

The Bear Case

While still not officially in a bear market, a combination of fundamental and technical factors are contributing to the rapid tumble in the Tel Aviv 25. Although the domestic Israeli economy remains in good shape, the exposure to the global economy remains the shaky leg of the stool. As a selloff sweeps across global equity markets, the TA-25 will never be fully insulated from the developments, adding to the case for further downside in the index.

Although the TA-25 is currently undergoing a bounce that will likely be reflected across the world at the weekly reopening, it does make a strong case for a total rebound back towards record highs. Even though accommodative monetary policy and the weaker Shekel are strong tailwinds for the index, the technical indicators tell a different tale and underline the bearish argument. With the bounce underway, the key for investors lies in identifying the proper entry point for short positions to exploit the softness encircling the TA-25.