Monday, February 7, 2011

Should Investors Be Concerned About Egypt?

Last week I sold most of my emerging markets exposure in my client accounts.

Don't get me wrong: I'm a big believer in investing in the fastest growing parts of the globe. Not only are countries like Brazil, South Korea, and, yes, China, posting very strong economic numbers, but their demographics (i.e. lots of younger people) bode well for growth in the years to come.

That said, I think that most would agree that the ride to prosperity in the emerging markets will not be a smooth one.

I think of investing in the emerging markets as investing in California in the early part of the 20th century: the future looks bright, but there will be many periods that it makes sense to step aside.

I think that the current time is one of those periods. I don't know what how the outcome of the unrest in Tunisia, Egypt, etc. will turn out, but I think we're seeing backlash between the huge wealth being created in relatively poor countries that are only benefiting a tiny fraction of the population.

This weekend's Financial Times had a good piece about the emerging markets written by columnist John Authers.

After noting that although there has been a modest outflow from emerging markets mutual funds, most of the market indicators indicate an overall calmness.

Indeed, there seems to sense of complacency, if not ennui, with scenes of thousands of Egyptians throwing rocks at representatives of an American-backed government.

However, Mr. Authers notes that at other times of crisis in the Middle East - the Yom Kippur war of 1973; the Iranian hostage crisis of 1979; and the invasion of Iraq in1990 by Saddam Hussein - the markets reacted in a very similar fashion to today. Initially there was a sense of denial, but eventually reality hit investors, and the markets took a tumble.

As Mr. Authers concludes his column:

Investors should still look at the underlying driver of discontent in the Middle East. Rising food prices are destabilizing many emerging markets on which the world relies for growth and have prompted equity investors to move to the exits. Low western interest rates add fuel to this fire. And oil is reaching prices that could damage even the less oil-addicted modern economy.

Therefore, it is still a concern that the markets in need of an excuse to sell off have instead opted to ignore a pressing reason for one.

I hope I am wrong, but I would rather err on the side of caution on this one.