Egypt At The Brink – Some Investment Implications

A year of incompetent and divisive government under President Mohamed Morsi and his backers, the Muslim Brotherhood, has led to massive and increasingly violent protests calling for the president’s resignation. The Egyptian economy is in dire shape with high unemployment, electricity blackouts, and very low foreign exchange reserves. Serious security problems have not been addressed. Morsi is seen as seeking to monopolize power for the Muslim Brotherhood through the new constitution and control of key institutions, moving the country towards an Islamic state. Millions are protesting in the street across the country, and civil war threatens.

The Egyptian army stepped in on July 1st with a 48-hour ultimatum, a “last chance,” calling on the political forces to resolve the political crisis or they will intervene to “impose a road-map for the future." It seems likely that the “road map” is a well-developed plan. The army’s praise of the protestors, "… displaying insistence and determination in a dazzling manner which sparked admiration locally, regionally, and internationally,” signaled the army’s lack of support for the country’s first elected president. The crowds in Tahrir Square cheered as army helicopters circled, displaying Egyptian flags. It is evident the Army will not follow any orders to suppress the protests. And the police would be unlikely to do so without the Army’s support. At the same time, the Muslim Brotherhood began staging rallies in opposition to any army intervention.

We don’t know how this crisis will evolve. It appears very unlikely that the two sides can come together within the 48-hour limit. President Morsi has rejected the army’s ultimatum. The Muslim Brotherhood and other supporters of the president are staging rallies in opposition to any army intervention. Should the military intervene, violent resistance by pro-Morsi Islamists could well develop. It does not appear that the army wishes to take over. More likely, it would support a move to an interim and inclusive government of civilian experts. Perhaps the president’s role will be reduced to that of a figurehead under a revised constitution. The position of the United States will be an important factor. The US has supported the democratic election process through which Morsi rose to power and would not likely want to see an outright military coup. But since the election, Morsi has paid only lip service to the concept of an inclusive democratic government.

The threat of increased political instability in the most important Arab country in the region is great. While Egypt’s economy is of minor significance to the global economy and capital markets, these developments are of considerable geopolitical importance for the Middle East and North Africa (MENA) region and hence to global energy markets. We will monitor the situation closely to detect any signs of regional contagion.

There are no immediate implications for our investment strategies. Our International and Global Multi-Asset Portfolios do not include any Egyptian or indeed any Middle East and North African positions. We review all available international ETFs using data and measures provided by the ETF Analytics Service of Index Universe and the ETF service of Ned Davis Research and select for our investment universe only those ETFs that meet our high standards of tradability and efficiency. This approach results in our not including in our portfolios the several ETFs for the Middle East region that have had strong advances this year but have very limited liquidity (WisdomTree Middle East Dividend (GULF), and Market Vectors Gulf States (MES). We also would not use the one Egyptian ETF, Market Vectors Egypt (EGPT), which not only trades poorly but also has a relatively high expense ratio of 96 basis points and as of the end of June was down over 25% year-to-date.

BY Bill Witherell