to HomeTurmoil in Egypt: Game-Changer for the Markets?
Special Commentary, by Chris Temple
Sunday, January 30, 2011
For starters, anyone who says they know what is coming next in Egypt specifically -- or perhaps in the Middle East generally -- is a fool or a charlatan. All we can do at the moment is look at probabilities and try to get the most informed views on the situation we can.
Thus, I have added to the front page of the web site an article from yesterday (Sat. the 29th) put out by Stratfor Global Intelligence. They offer a subscription-based service, to which we subscribe, offering intelligence and insight on a myriad of subjects; and have always struck us as reasoned folks providing careful research, rather than folks with a preplanned agenda or viewpoint. This item, entitled "The Egyptian Unrest: A Special Report," is reprinted with permission.
Likewise, I will not claim to know what the lasting effects (as opposed to, possibly, those of just last Friday) will be on the various markets because of all this. Further along, I will give my take on several markets and express what I think the probabilities are for the coming days/weeks. (NOTE: In these comments I am conspicuously not making ANY specific recommendations on investments, which is in any case reserved for paid subscribers to The National Investor. If you are not already a subscriber and would like to learn how to become one, CLICK HERE.)
THE PROBABILITIES IN EGYPT
As a precious few sensible and realistic journalists have pointed out over these last few days, the mere fact that some journalists are able to locate English-speaking protesters in Cairo or elsewhere does not mean that all of these protests are necessarily being orchestrated or run by "democratic reformers." The simple fact is that the present political turmoil in the country of Egypt--and specifically the fate of President Hosni Mubarak--stems chiefly from a battle over succession within the military cabal that has ruled Egypt for some 60 years. Perhaps Mubarak thinks he has served long enough to give him the right to handpick his son Gamal to succeed him. Egypt's military rulers disagree; and Mubarak already seems resigned to their will.
Accordingly, Egypt’s former air force chief Ahmed Shafiq, has been picked by Mubarak to be prime minister, and to form the country's next Cabinet (after Mubarak dissolved the old one.) Further, Mubarak has appointed Egyptian intelligence chief Omar Suleiman as vice president (rather than his own son.) The most likely outcome over this whole squabble will be that Egypt's military establishment remains in charge following whatever real or "show" elections might materialize. The Suez Canal will not be closed (certainly not by any official act emanating from Egypt's government) nor will there be any significant change to the balance of power in the Middle East.
Are there risks to this outlook; ones which would lead to bigger geopolitical problems as well as problems and upheavals for the markets? Certainly. It is not outside the realm of possibility that more energetic Muslim forces could in the end take over in what for some time has been an effectively secular state. Such fears have understandably increased given the other instability of late in the region (chiefly, in Lebanon and Tunisia.) It is no secret that more "radical" Muslims would like to retake one country after another especially where, they feel, the present leaders have become little more than stooges for the U.S. But by and large, most of these types have little real ability to bring their plans to fruition. This is especially true (or should be) in Egypt, where the military is well established and extremely powerful.
The starry-eyed liberals, journalists and others thinking that "democracy" is about to flower in Egypt would do themselves and the rest of us well to remember what happened a little over 30 years ago in Iran. There, the formerly U.S.-backed Shah Reza Pahlavi was abandoned by this country when what were portrayed as the same type of popular uprisings for individual rights and democracy were taking place. But in the end we ended up with something much different than the kind of government we were led to believe would replace Pahlavi. The Shah might not have been a barrel of laughs; but his ouster removed a fairly docile, American-friendly government (certainly in the sense of regional politics and the balance of power) and replaced it with something much worse.
Frankly, my big concern is not that a group in Egypt like the Muslim Brotherhood has a snowball's chance of gaining any significant political power without some help. It is that--like with Iran--we may well be in the process of throwing away a "devil we know" for an unknown. Secretary of State Clinton was this morning calling for an "orderly transition to democracy" in Egypt.
But she (and the average American) seems to always forget that--in that part of the world in particular--you have people who are naturally inclined to follow some sort of authoritarian leadership.. For several decades in Egypt, this has meant effective military rule. The alternative, if it comes to this, may well be some form of authoritarian Muslim regime. Among other things, this latter would probably mean the end of what some have called "The Cold Peace" in the Middle East that has existed since Camp David.
By the way -- Is it just me, or is there something strange about the U.S. government suggesting that Americans presently in Egypt leave, and that those contemplating travel there stay home? One would think that if what we're seeing on television really were spontaneous, popular uprisings for "democracy," any identifiable American would be viewed by the people in the streets as a rock star or a hero. That there is some apparent danger to them suggests that Americans in Cairo are not looked at, even in "secular" Egypt, as were the Allies as they entered French cities in 1944. This should (but unfortunately won't) raise questions about both the wisdom and truthfulness of our foreign-policy at its core, together with Americans' pathetic lack of understanding of what motivates the average Arab citizen.
But that's all a story for another day.
In summation, on this point, it is most probable that some order will be restored in Egypt before too many more days go by. The same power structure will still run the country, even if a nod must be given to "democracy" in the form of allowing one or more non-military types some power.
Among the possible alternatives to such an outcome, the two most worrisome ones are that...
1. ...The Muslim Brotherhood and/or similar groups are able to sufficiently destabilize the country so as not to allow a fairly quick return to order. Were the troubles in Egypt occurring in some isolation, they would be less worrisome. But politically-minded (and Western-hating) Muslims are feeling their oats these days. They don't have the upper hand everywhere, but will gladly spread discord where possible in trying to provide the appearance of some glorious, region-wide popular uprising for oppressed Muslims everywhere. The longer it takes for the Egyptian authorities to quell the protests which, if anything, are now escalating, the better the chances for this whole uprising to be "hijacked" Iranian-style.
2. ...The military ends up at war with itself. Some suggest that there are officers below the most tenured senior ones in the establishment that have their own grievances, together with their own political agendas. This bears watching, as it would destabilize the country even more than the current protests.
THE PROBABILITIES FOR THE MARKETS
This past Friday saw the most tumultuous day for the financial markets in a few months' time. What one would have expected given the dramatic ratcheting up of geopolitical fears happened pretty much across the board. Oil, gold, Treasuries and the U.S. dollar spiked higher. Stocks suffered their biggest one-day drop in over two months.
What was noteworthy about these moves is that pretty much every one of them reversed the direction each asset class was going in before the Egypt developments were front and center in investors' minds. The question thus is--particularly if some order is restored sooner rather than later and these anxieties lesson--whether the old directions of various assets will resume or not. The second question is to what extent the moves of this past Friday will (or can) continue if the unrest does not subside shortly, let alone spreads.
Here are my observations and thoughts on some key asset classes:
1. The most dramatic move on Friday among various markets was the nearly $4 per barrel jump in the price of crude oil. Fundamentally, oil's near-term outlook had again turned fairly weak. As I had described for my subscribers several days previously, OPEC has sense enough to know that if oil were to move too high, it would prove a dampening effect on worldwide growth. Thus, it has been bumping up production. Further, inflation-fighting efforts in several developing nations (a subject covered in the cover story of the upcoming new issue of The National Investor) was also helping a few traders to realize what I have been shouting for a while: that commodities are not only some magical new asset class, but are also a cost of goods sold...and a cost of living.
Without these new geopolitical fears, oil was undoubtedly on its way back to $80 per barrel. Over the coming few months, I was willing to wager that it would move even lower than that, if for no other reason than that pretty much all risk assets needed to correct/consolidate for a while. Friday's spike will prove short-lived if the Egyptian authorities are able to quell the protests.
The flip side, naturally, is that continued or growing unrest likely will push oil higher. But it will not be because demand is increasing; indeed, a protracted price spike due to such non-economic factors will almost surely lead to dampened growth and corresponding trouble (chiefly, falling stock prices) elsewhere.
2. Gold had been suffering some serious technical damage in the few days prior to Friday's bounce for the yellow metal, which took it to a close back above the key technical level of $1,325 per ounce it had broken. If you are a gold bug, you are happy right now over the whole Egypt mess, since it has served to help stem the bleeding in the gold market which would have undoubtedly continued.
Frankly, especially given that it was already so oversold, the fact that gold did not continue building on its gains through the close of trading (as oil did) should be worrisome if you are still long gold very much. All else being equal, I would expect to see gold drop back down even faster than oil if Egypt stabilizes quickly. The alternative--prolonged or increased tensions--do have the potential to suck traders back into the gold trade. We will need to see the recent pattern of lower highs and lower lows broken first, however, before it could be judged safe to trade back into gold in a meaningful way this soon.
3. U.S. treasury bonds had been in some renewed distress themselves of late also. They also performed according to the usual script on Friday, rallying strongly due to their safe haven status; and this, despite the news of only a few days previously that the expected federal budget deficit for FY 2011 will now be more like $1.5 trillion rather than the $1 trillion previously predicted.
If you read my 2011 Special Forecast Issue, you will know that I began the year bullish on Treasury bonds. I remain so; especially if the Egypt situation does not resolve itself quickly.
4. Perhaps the most interesting player among safe haven assets that caught a bit on Friday is the U.S. dollar. Unlike the beginning of 2010 when I was certain the dollar was going to enjoy a good run higher against most other currencies (and was proven right) I have not had that confidence in the greenback lately. Indeed, the dollar's behavior in recent days had been downright horrid, especially as Europe's masters have once again gone to great lengths to assure the markets that all will be well, and that the euro will not collapse anytime soon. Especially curious to Yours Truly was the fact that the dollar was weakening even as industrial commodities (and oil and gold) were experiencing some weakness.
Even more so than with gold, the dollar might be able to claim soon that it was rescued from a BIG new down leg by the chaos in Egypt. Here too, we'll watch for sufficient repair to the recent technical damage--together with larger new inflows--to tell us if and when it is time to be long the U.S. dollar again now.
5. As I explain in my upcoming issue, commodities generally were appearing to be topping out and heading for, at the least, a relatively short (time-wise) but sharp correction. What will be interesting to watch if tensions remain high in Egypt and--more broadly--the whole Middle East/North African area is how much harder some commodities might get hit due to investors' fears that all these new uncertainties and a spiking oil price (if in the end a temporary one) will again cripple economic activity.
Watch for a renewing inverse relationship between the U.S. dollar's value and that of most commodities. Were the dollar to take off for a while as safe haven money pours into it in the event that Egypt's woes continue or worsen, that would likely in and of itself lead to falling prices.
6. Finally, we'll talk here about the one major asset class that was still rising before all of fund started: stock markets.
In and of itself, a drop of 160-some points in the Dow Industrials and others of an average of 2% in other broad measures would mean relatively little after so many weeks of a steady (if less spectacular) climb higher. But we must look at what stocks were doing (or, more to the point, not doing) before Friday. As I wrote to subscribers last week, it was already looking as if stocks were simply too tired to move on. Nobody was going to be unwilling to forgive "Mr. Market" if a 5 to 10% correction finally materialized; one which some of us think is obscenely overdue.
The fact that the bulls were having so much trouble pushing stocks convincingly above the key psychological levels of 1300 on the S&P 500 and 12,000 on the Dow before Egypt captured the attention it now commands is telling. Now, the bulls have the comfort of being able to blame market weakness on this. As one commentator said on Friday, sometimes it takes an event out of left field as a means for stock traders to be able to "justify" taking profits in an overbought market when they otherwise are afraid to.
A few technicians pointed out at the end of the day on Friday how--though it represented a mere one day's trading--serious technical damage has now been done to stocks. Not only did Friday represent an "outside day" for the S&P 500 (this is where the market first trades higher than the previous day's high, before closing lower than the past day's low level) but it also gave us an outside week. Such sharp technical reversals do not always lead to a sustained downtrend; but if things don't get straightened out in Egypt fast, it's safe to say that we have indeed seen a top in the market for now.