Egyptian Stock Market: Why Political Turmoil is Stifling This Emerging Market’s Growth

by Carl Delfeld, Investment U’s Global Equities & Emerging Markets Specialist
Monday, January 31, 2011: Issue #1439

The thought of investing in Egypt at the moment seems crazy.

But before the current political crisis hit, I toyed with the idea of adding the Market Vectors Egypt ETF (NYSE: EGPT) to the more aggressive, growth-oriented portion of my global portfolio.

After all, the Egyptian stock market, and the ETF that tracks it, offers adventurous investors an intriguing opportunity at the heart of Arab culture and history.

• Over the last six months of 2010, Egypt’s market received a net inflow of about $1.2 billion from foreign investors. International investors also account for about 25% of trading on most days, according to Khaled Seyam, the exchange’s chairman.

• While the country’s stock market is small, sporting a value of about $78 billion (to put that in perspective, Apple’s market cap alone is $309 billion), it’s the best-regulated bourse in the region.

• From a valuation perspective, Egypt is attractive. Of the 20 countries represented in the iShares Emerging Market Index (NYSE: EEM), Morgan Stanley ranks Egypt third in price-to-book value and fourth in price-to-earnings.

In addition, the Egyptian market has soared almost ten-fold since 2003. And over the past decade, market reforms, coupled with increasing domestic demand from a rising middle class, have helped drive Egyptian GDP growth to a healthy 5% over the past few years.

But the progress has temporarily taken a back seat, with the current political turmoil engulfing the country. And if there’s one thing that markets hate, it’s uncertainty. This is often amplified in emerging markets, which are more susceptible to economic and political volatility and can swing dramatically on such pivotal events.

And at the moment, the situation in Egypt couldn’t be more uncertain…

Political Pressure Cooker

Despite Egypt’s economic and market gains, the improvements for the Egyptian people themselves have been uneven.

Poverty remains rampant in many parts of Egypt. The national poverty rate in this large Arab nation of 82 million people sits at an ugly 40%. That’s exacerbated by the 8% core inflation rate and the alarming surge of food price inflation, which breached 22% last August. Food and energy subsidies now exceed 7% of GDP.

This brings us to the political power struggle to succeed President Hosni Mubarak, the ailing 82-year-old leader, who took charge after the assassination of Anwar Sadat in 1981.

Mubarak has managed to keep a lid on these simmering pressures and suppress Islamic extremists, but his health and apparent lame-duck status in the upcoming September election has boiled the waters. In addition, recent public uprising that toppled the president of Tunisia has emboldened Egyptian protestors to take to the streets, too, with former Director-General of the International Atomic Energy Agency Mohamed ElBaradei the standard-bearer for their grievances.

Right now, pro-Western Egypt seems torn between the people’s desire for democracy and Mubarak’s will to retain power and implement reforms.

And as Winston Churchill once put it, “The terrible ‘ifs’ accumulate.”

Politics Trumps Numbers

For example, will Egypt remain pro-Western and at peace with Israel? Or will Egypt’s largest opposition movement, the Muslim Brotherhood (tolerated but officially banned), gain the upper hand?

On which side will the military ultimately fall? It’s currently unclear, but a vitally important issue.

In this murky environment, rumors are flying fast. Mubarak’s son, Gamal, was reported to have fled to London, along with his wife and children.

The lesson here: Keep a close eye on politics, particularly when it comes to emerging markets, as politics usually trumps the numbers. In places like Indonesia and India, for example, the re-election of a head of state can propel markets forward.

But in Egypt’s case, the uncertainty is a clear red flag. In fact, Bloomberg reports that Egypt is now seen as riskier than Iraq, according to the cost of insuring against sovereign debt defaults.

For their part, both President Obama and Hillary Clinton chose their words very carefully over the weekend. Mindful of Egypt being a major United States ally in the region, yet also supportive of a more democratic process, they repeated their desire to see an “orderly transition” in Egypt.

One thing is certain: International pressure on Egypt to resolve the situation is growing. And with tourism accounting for some 5% to 6% of GDP, it’s in Egypt’s best interests to do so.

Good investing,

Carl Delfeld

Editor’s Note: While the Market Vectors Egypt ETF has lost 20% of its value in 2011 alone, due to the volatile situation in Egypt, that doesn’t mean you necessarily should snub emerging markets altogether.

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