As inflation rears its head around the world, Israel is no different from many other countries that have seen prices spike as of late.  Where Israel differs from the rest of the world is not in experiencing inflation, but how the economy is leveraged to it.

Let me explain: Israel suffered from bouts of hyperinflation during its 60 years of existence.  Most salient was the 1970s which saw double digit inflation throught the decade, culminating in 100+% inflation in 1979.  The beginning of the 1980s introduced stagflation and saw even higher inflation rates.

Here’s where the history impacts today’s Israel: in an effort to combat hyperinflation, Israel created an economy-wide phenomenon of CPI-linked debt.  This debt is not specific to a specific sector and according to a report produced last week by UBS’s Israel analysts, may compose over 50% of corporate debt, over 60% of the government’s shekel debt, and 60% of mortgages.

After the last couple of boom years 2005-2006, most of the corporate debt raised by Israeli firms is also linked to the CPI.  Merrill Lynch is out this morning as well with a study on the effects of higher CPI on Israeli firms.

The money line from the UBS report: However the spike in CPI in Q2 could affect the bottom lines of many Israeli corporates and we are concerned that a continued high inflation could continue to weigh on the profitability of many Israeli companies.

So, what’s an investor in Israeli firms traded in the U.S. to do?  UBS suggests underweighting those institutions with high CPI exposure.  The storm feared by analysts would play out with consumers being hit with rising prices in the market also being compounded with resets in adjustable rate mortgages that are linked to the CPI.  In turn, this could curb consumer spending which is playing a bigger and bigger role in GDP growth.

While Olmert clings to a feeble position in a government beset by scandal, UBS suggests that “the rise in CPI will also have fiscal implications as the Government could be squeezed by paying more on its CPI linked debts as well as collecting less corporate taxes.”

Zack Miller
IsraelNewsletter.com

(Another Globes article out this morning entitled ‘Ticking Bomb‘)

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Aaron Katsman
IsraelNewsletter.com

Red Red Red- That’s what the tape shows,
the market is going down everyone knows;
Step up and buy stocks off we go,
Homer, what would you say to a bank failure, Doh!

Sub-prime, oil, inflation and a weak dollar are to blame,
A year ago wasn’t the situation the same?
What goes up must come down was Newtons claim to fame,
It looks like only the shorts will be left standing at the end of the game.

Israeli stocks in the US have been shown the door,
but at current valuations isn’t there a floor?
Bears point to Iran and potential war,
Bulls say deal after deal signed, a rally we are in for.

Silicom (SILC), Alvarion (ALVR), Zoran (ZRAN), Amdocs (DOX) the list has no end,
It doesn’t look like the reversal is just around the bend;
Global banks are stuck they have no money to lend,
It will take time for all the carnage to mend.

But be optimistic there are deals to be had,
What’s great today used to be bad.
If you hit refresh on your portfolio you are sure to be sad,
Don’t fret a few good days and buying stocks will again be a popular fad.

Disclosure: Author’s fund has a position in SILC, DOX, ZRAN, ALVR. He has no position in any other stock mentioned as of 7/08/08.

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Aaron Katsman is Managing Editor of the Israel Opportunity Investor newsletter. He is lead portfolio manager for the Israel Growth Portfolio and Managing Director of America Israel Investment Associates, LLC. For more information, go to www.israelnewsletter.com or call 1-888-327-6179, or email aaron@profile-financial.com.

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Aaron Katsman
IsraelNewsletter.com

I posted yesterday about how a strengthening US Dollar could potentially benefit Israeli stocks that trade in the US. I was asked by some readers how come I think that the USD is poised for a rally? The answer…FIFO. FIFO is an accounting term that stands for ‘first in first out.’ With the global economy on the skids, the US was the first country to start having problems and with a vigilant Fed at the wheel, I think the US will return to normal growth in the next 6 months. After all, no recession occurred. The US has had no negative GDP growth quarters, and actually had a surprisingly good 0.9% GDP for Q1. Europe on the other hand, is just starting to show signs of a slowdown. I have heard analysts predicting a potential contraction of over 2% in European growth. That certainly will be bullish for the greenback.

I really think investors need to keep an eye on what’s happening in South East Asia. Asian stock markets like Vietnam rocked and rolled during 2006-07, unfortunately, steep market drops and a worsening economic situation may be a precursor to another Asian financial crisis like we had 11 years ago. Keep in mind that the Vietnam market has lost more than 55% during ‘08, and with inflation jumping, the currency has dropped. This isn’t just an issue in Vietnam. Countries like India, China, Philipines and Hong Kong are all in the midst of spiking inflation, and in the case of the Philipines and Thailand for example, sinking currencies. (Continue »)

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Smart investors know how to look at company provided projections. You’ve got to take them with a grain of salt.

So, when Israel’s Finance Ministry begins making bold projections, you probably require at least a bucket full.

(Continue »)

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