When the Berlin Wall came tumbling down in 1989, it touched off a sustained rally in European stocks. Well, the Israeli-Palestinian peace accord is shaping up to be just as consequential an event for the bourses of the Middle East, particularly in Israel.

Israeli stocks have climbed a dazzling 14% in the two weeks since word of the pact was announced (chart)--a stunning upturn for an equities market that sizzled for nearly three years but cooled this summer (BW--Aug. 9). True, trading volume remains small--a mere $150 million in shares changed hands on Sept. 5, and that was a record. But with peace prospects looking better than ever, an influx of overseas dollars should continue to propel Israeli stocks and may even spill over to other markets in the area--from the lively exchange in Istanbul to the sleepy bourse in Cairo, which has yet to benefit from peace euphoria. "With the agreement, it's possible Israel will finally make it as an emerging market and attract institutional investors, investment firms, and individual investors," says Dan Galai, managing director of Sigma PCM, a money management firm based in Tel Aviv.

There's good reason for such optimism. Because of worry over political instability, even the huge gains in 1991 and 1992 didn't bring foreign investors into the market. But that is changing fast. Israeli bankers say that within the past month, several leading Wall Street brokerages have opened trading accounts at Israeli firms. However, the recent rally took place without their help. Investors poured nearly $1 billion into the market during the week following the announcement--and little of that was foreign capital.

REGIONAL FUND? Up to now, foreign investment in Israeli companies has been accomplished almost exclusively through the nearly 60 issues of Israeli companies traded in the U.S. They include a number of widely followed high-tech companies such as Scitex Corp., ECI Telecom, and Lannett. But with a market capitalization of $40 billion--which is larger than the markets in Austria, Belgium, and even Spain--there is growing interest in investing directly in the Tel Aviv market. "We're planning to introduce a number of Israeli companies which trade exclusively in Tel Aviv to American investors later this year," says Howard Sterling, managing director of corporate finance at Oscar Gruss & Son Inc., a market maker in many Israeli shares. Last month, Lehman Brothers purchased $1.5 million worth of shares of Bank Leumi, in an indication of the growing foreign interest.

True, the market rally could evaporate if the talks collapse. But most experts are predicting that the conditions are favorable for a continued rally even if there are temporary setbacks in the peace process. "Unlike 1979, when Israel and Egypt signed a peace treaty," says Zeev Holtzman of Giza Ltd., a Tel Aviv investment bank, "the latest agreement finds the Israeli economy in the midst of a boom." And the accord would enhance the Israeli economy still further by trimming Israel's huge defense budget and reducing other war-imposed burdens. Even before the accord, economists were forecasting a return to rapid growth in 1994.

In the past week, just about every stock in the market has benefited from the rally. But Dov Gilboa, director of Bank Leumi's investment department, believes certain sectors--such as tourism, infrastructure, real estate, and high tech--are likely to reap the quickest benefits from peace. Holtzman foresees the establishment of a regional fund with stocks from Middle Eastern markets.

The Palestinians, meanwhile, have no stock market to raise capital for their private sector, which can be expected to boom. A World Bank report on the West Bank and Gaza Strip, due out soon, is expected to recommend, among other things, the establishment of a stock market in the areas to be governed by the Palestinians. Now there are only about 30 to 35 publicly held companies in the West Bank and Gaza Strip, and there is no market for their shares. Instead, they depend on bank loans and direct investments from private investors as the major sources of investment capital.

If the nascent Palestinian stock market were to look to a role model, it might well turn to the Tel Aviv exchange and not to the Arab bourses in Cairo and Amman. In contrast to the high-tech Tel Aviv exchange, the Cairo market is more akin to a Middle Eastern souk. The exchange operates in slow motion. When a broker makes a trade, he writes the details on a piece of paper, slips it into a basket, and rings a bell. A man on a narrow catwalk pulls up the basket and chalks the new price onto a blackboard next to the company's name.

But the exchange is stirring. Attracted by President Hosni Mubarak's shift toward a market-oriented economy, rich Egyptian expatriates and Gulf Arabs have placed billions of dollars in Egypt in the past year. Adventurous Western investors are also giving the country a serious look. While most of the money has gone into short-term government securities, some of it is finding its way into the stock exchange. An index compiled in Cairo by Kidder, Peabody & Co. of 23 actively traded stocks is up 39% in 1993--a remarkable performance, considering the government is locked in a struggle with Islamic militants that has left about 130 people dead. "We feel that a new character has been pumped into the market," says Nassef Nazmy, one of the exchange's leading brokers.

Some 600 companies are listed on the Cairo exchange, but only about three dozen are actively traded. Many of these are state companies slated for privatization. The hottest stock is Suez Cement Co., whose price has doubled in the past year, to about $6. The Israeli-Palestinian peace talks have failed to have much impact on share prices in Egypt. The Kidder Peabody index has crept up only 2% since Aug. 17, according to Aladdin Saba, vice-president of the firm in Cairo. But Saba thinks that traders are being shortsighted and that the prospects for peace will eventually make the Egyptian market much more attractive.

Saba notes that Arab-Israeli peace "will defuse a lot gf political uncertainties that people had about the area." Already shares of Misr Hotel Co.--which owns the Nile Hilton--have climbed some 10% in recent weeks, after falling sharply earlier in the year when militants began targeting tourists. Peace will also make it easier for the Egyptian government to move ahead with its privatization program--something that should further breathe life into the Egyptian market.

Portfolio managers may begin to hone in on Cairo as well as Tel Aviv. One of the boldest, J. Mark Mobius, president of Templeton Emerging Markets Fund Inc., has visited Cairo already. He says he is attracted to the Islamic world's preference for equities over debt, but he is holding off because of problems finding an Egyptian stock custodian.

With the exception of Istanbul's booming stock market, other Middle Eastern bourses have yet to match Israel's as a source of capital-raising. Amman has a small but active exchange, but the market participants are mainly Jordanians. Saudi Arabia has an active stock market with some 62 issues, but only Saudis and nationals of the Gulf Cooperation Council can trade there. One Riyadh-based banker says that a number of British and American investors have journeyed to Riyadh and Jeddah lately to explore the purchase of Saudi stocks as part of their Middle East portfolios. That can be done legally through Saudi nominees or trustees. Apparently, however, no one has yet taken the plunge.

PEACE PIPE. One other Mediterranean market likely to benefit from peace is the Istanbul Stock Exchange. "We're not exactly perched on the West Bank, but peace is going to have a general beneficial macroeconomic effect here," says Emre Yigit, head of research at Global Securities, Istanbul's largest brokerage. At $25 billion, Istanbul has the second-largest market cap in the region, and it is also one of the best-performing equity markets in the world this year: Its rise, adjusted for currency swings, has been about 125%.

Many of the 160 companies listed on the exchange do regional Mideast business, particularly large contractors such as Alarko and Enka. Such companies could reap huge dividends from the peace. Ankara may reactivate its moribund multibillion-dollar Peace Pipeline Project, designed to pipe enormous quantities of Turkish water to the parched Israeli, Syrian, Palestinian, and Jordanian farmlands. In the past, the lack of an Israel-Arab peace agreement made the project unrealizable.

Such once unimaginable economic developments are likely to proliferate once peace is achieved. And as peace euphoria spreads throughout the Middle East, this backwater of the investment world bids fair to become a veritable burning bush of opportunity.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE