Navigating Israeli Equities: Inflation Relief and Geopolitical Crosscurrents

As Israel's inflation rate dipped to 3.1% in May 2025—the lowest in over a year—the economy is showing signs of stabilization after years of conflict and fiscal strain. Yet, the specter of geopolitical risks lingers, complicating the outlook for investors. With the Bank of Israel maintaining its benchmark rate at 4.5% and GDP growth rebounding to 3.4% in Q1 2025, the time is ripe to dissect opportunities in Israeli equities while weighing the dual forces of macroeconomic recovery and regional instability.

The Macroeconomic Rebound: A Fragile Foundation

The easing of inflation, driven by falling transport and utility costs, has been a bright spot. However, the Bank of Israel remains cautious, citing geopolitical tensions—particularly ongoing conflicts in Gaza—as a key risk. The central bank's decision to keep rates steady signals an acknowledgment of lingering inflationary pressures, such as rising utility bills and tax hikes, which are projected to push prices to 4% early in 2025 before moderating to 2.6% by year-end.

The Q1 GDP growth of 3.4% (annualized) reflects a post-ceasefire rebound, with construction leading the charge. Construction spending surged 44.9% quarterly, reversing earlier declines caused by wartime conscription and labor shortages. This recovery, fueled by pent-up demand and rebuilding efforts, has positioned the sector as a cornerstone of near-term growth.

Source: Bank of Israel

Sectors to Watch: Where the Opportunities Lie

Construction and Real Estate

The construction rebound is the clearest investment signal. With housing starts rising and commercial projects resuming, companies like Shikun & Binui, Israel's largest construction firm, stand to benefit. Additionally, the government's push to rebuild infrastructure and housing stock—amid a labor market recovering from wartime disruptions—creates a tailwind.

Technology Sector: Navigating Challenges

Israel's tech industry, responsible for ~20% of GDP, faces headwinds. Emigration of skilled workers and conscription-driven labor shortages have led to job losses (5,000 in 2024) and reduced R&D output. However, cybersecurity firms like Check Point and AI innovators like Mobileye (a subsidiary of Intel) remain global leaders. Investors should prioritize firms with diversified revenue streams and exposure to secular trends like AI and cyber defense.

Defensive Plays: Utilities and Healthcare

Geopolitical volatility favors defensive sectors. Utilities, such as IDE Technologies (water desalination), and healthcare providers like Clalit Health Services are less sensitive to macro swings. These sectors also benefit from government spending on public infrastructure and social services.

Geopolitical Risks: The Sword of Damocles

While the Hamas ceasefire has reduced direct conflict, the Bank of Israel warns that renewed fighting in Gaza could disrupt labor supply and investment. Gaza's economy, having contracted by 86% since late 2023, remains a flashpoint: its collapse exacerbates regional instability and strains Israel's labor market, as Palestinian workers once contributed significantly to construction and agriculture.

The debt-to-GDP ratio, projected to exceed 70% in 2025, adds another layer of risk. Military spending now consumes 20% of the budget, squeezing public services and fueling strikes. Investors must monitor fiscal discipline and the trajectory of military operations, as prolonged conflict could derail the economic recovery.

Investment Considerations: Balance Caution with Opportunism

1. Overweight Construction and Real Estate: The sector's growth trajectory is clear, but monitor labor availability and permitting delays.
2. Underweight Pure Defense Plays: While defense stocks like Elbit Systems may offer short-term gains, long-term exposure is risky amid shifting geopolitical dynamics.
3. Focus on Tech with Diversification: Prioritize tech firms with global clients and minimal reliance on local labor.
4. Monitor Central Bank Policy: A rate cut in late 2025 (anticipated to 4.0%-4.25%) could boost equity valuations, especially for rate-sensitive sectors.

Conclusion: A Delicate Equilibrium

Israel's equities present a compelling case for investors seeking growth amid stabilization, but success hinges on balancing optimism with risk awareness. The construction rebound and tech sector's resilience offer entry points, while geopolitical risks demand a watchful eye. For now, a tactical allocation to Israeli equities—focused on cyclical recovery and defensives—appears prudent, with a preference for companies that benefit from structural trends rather than fleeting macro tailwinds.

Investment Recommendation:
- Buy: Construction stocks like Shikun & Binui and tech firms with global reach (e.g., Check Point).
- Hold: Defensive utilities and healthcare.
- Avoid: Pure defense plays without diversified revenue streams.

Stay vigilant for geopolitical triggers and macroeconomic data releases, but do not let uncertainty overshadow Israel's underlying growth potential.