The current turmoil in Egypt, while troublesome, is not likely to have serious repercussions on world financial markets. From an investment perspective, the situation becomes more serious if it causes a major disruption in oil supplies. This would occur only if the government of a major oil-producing country, such as Saudi Arabia, was overthrown, or a major war in the Middle East broke out.
Last year problems in Greece led to a significant, though temporary correction in world markets. Clearly a valid concern would be if Egypt would cause a similar correction. A key difference between Greece and Egypt is that the situation in Greece was a financial problem, whereas in Egypt it is a political one. In addition, Greece was important being part of the Eurozone, where a default impacts all of Europe and has major consequences on the banking system throughout the continent. In Egypt, however, financial activities are not that significant, though clearly the political repercussions are.
While Egypt has a large population of 84 million people, it is not a major oil producer. Therefore, a change in government in Egypt should not impact oil prices. Even if a new government in Egypt is more hostile to the United States and Israel, the economic ramifications will likely be minimal, unless it leads to a major war.
One impact Egypt has had thus far has been to cause further weakness in emerging markets. As I discussed in my last column, emerging markets had already started to weaken, as a number of countries have raised interest rates to combat inflation, and the crisis in Egypt just intensified that weakness. During the past week there was a large outflow of $7 billion from emerging market funds, as investors became more cautious. While concern over Egypt is understandable, the likely economic spillover effects to emerging markets in Asia and Latin America would be virtually non-existent.
Given the volatile nature of emerging markets, there could certainly be continued near-term underperformance, but short-term timing is very difficult. Therefore, for a longer-term investor I would not recommend selling emerging market funds at the present time, as these countries will experience faster growth over time. However, because of greater political instability in emerging markets versus developed countries, it is critical to be well diversified across many countries to control risk.
Longer term, a new regime could be quite positive for Egypt, though in the short run the transition will probably be painful. For a poor country Egypt has a fairly well-educated population, so it clearly has potential. Unfortunately, Egypt has an entrenched bureaucracy that has made new business development cumbersome and very time consuming. How a new government establishes and enforces regulations will be critical for Egypt’s future financial health.
For the U.S. stock market, it appears that Egypt will not cause a major impact on prices. Nonetheless, the situation does need to be closely monitored in the event that hostilities develop throughout the Middle East. For now most economic news in the U.S. is somewhat better, especially corporate earnings, which were quite strong in the just-completed fourth quarter of 2010.
