The following commentary comes from an independent investor or market observer as part of TheStreet’s guest contributor program, which is separate from the company’s news coverage. The opinions expressed are those of the author and do not represent the views of TheStreet or its management.
NEW YORK (TheStreet) — Egypt’s longstanding president, Hosni Mubarak, stepped down Friday, Feb. 11, 2011 after 18 days of widespread protests. The turmoil and change in leadership in Egypt meant little for most stock and bond markets. Oil prices fell despite the potential disruption to oil transport and the risk of a spread of the unrest to oil producing neighbours. In 1971, Pete Townsend wrote one of The Who’s biggest hits: Won’t Get Fooled Again. 40 years later, his take on the lack of any real change resulting from revolution could be applied to the events that have transpired in Egypt.
Far from a revolution, for investors the events mark a minor evolutionary shift in Egypt and the region. Since a military coup in 1952, all of Egypt’s presidents have been military leaders. The military is the most central institution in all of Egypt. Like his predecessors, Nasser and Sadat, Mubarak served as President at the will of the military. The military was in charge during Mubarak’s 30 years as President, they were in charge during the 18 days of protests, and they remain in charge now. The demonstrators are cheering, cleaning up, and going home. The military maintained the support of the people. Any elections are likely to involve candidates that are de facto selected by the military.
The military stated over the weekend of Feb. 12-13, 2011 that it will abide by all the former treaties, including the 1979 peace agreement with Israel. This is a big part of restoring normal diplomatic relations with the United States and other benefactors. Internally, the army may declare martial law to get everyone off the streets and back to work in short order. They may also attempt to undermine the popular Muslim Brotherhood political opposition group by invoking fears of radical Islamists having entered the country during the chaos (former Egyptian president Sadat was assassinated by Islamists). The military is working as rapidly as possible to return things to normal both externally and internally.
Markets have shown little reaction as investors watched to see if real change was coming and if the seeds of revolution were spreading around the region. Egypt provided an example of the unrest that can be fuelled by rising food prices. Major importers of food and energy, such as China and India, have already have seen a negative impact on their markets. Social stability could also begin to unravel if soaring food and energy prices are not addressed in emerging market countries where they make up a large portion of consumer spending. The theme of reflation is becoming a dominant one for 2011 and may in fact be the true revolution taking place for investors as it defines the performance of all markets so far this year.
The geopolitical events in Egypt had the potential to turn investors’ attention back to concerns about the durability of global economic growth that prevailed last summer. Instead, investors appear to be less worried about growth retreating and are starting to differentiate their investing based on prospects for reflation and rising interest rates. What seemed to be a world locked into one unified global business cycle a year ago is becoming more and more decoupled as each market classified by size, country, and sector show differing reactions to the return of inflation and the rise in interest rates.
- Stocks and bonds have followed different paths with the S&P 500 up 6% and the Barclays Aggregate Bond Index down 1% year-to-date. An improving growth outlook and the risk that rising food and energy prices will spread into other goods and services have pushed up long-term bond yields to the highest levels in almost a year.
- The impact of rising interest rates can also be seen in smaller companies, which generally have a greater dependence upon favourable borrowing conditions, as they have underperformed their Large Cap peers this year after generally outperforming since the market low in March 2009.
- When prices reflate, commodity producers are typically beneficiaries. Not surprisingly, the best performing sector of the stock market this year is Energy. This year’s worst performing sector is Consumer Staples, where companies face the high cost of food and energy inflation as inputs to their products. Also, the most interest-rate-sensitive stock market sectors, telecommunication services and utilities, are among the worst performers this year as rates have risen.
- Emerging Markets have been underperforming developed markets this year for the first time in quite some time. Reflation has been more prevalent and problematic in the Emerging Markets. Rising inflation, mainly food and energy prices, have been spurring unrest in a number of emerging market countries such as Egypt, central bank rate hikes in countries such as China, and a booming economy in places like Brazil are pushing up interest rates. The MSCI Emerging Markets Index is down 5% this year, while the MSCI EAFE and S&P 500 Indexes that represent developed markets are up 4% and +6%, respectively.
- Even within the Emerging Markets the reactions to the return of inflation have been different. The stock markets in those Emerging Market countries that benefit from rising prices (oil and food exporters) are faring well this year, such as Russia (+7%), Nigeria (+7%), and Iceland (+6%). While some Emerging Market commodity importers have suffered, including India (-15%) and Brazil (-5%).
The theme of reflation is defining the relative performance of all markets so far this year. We expect reflation to remain a key theme for all of 2011. This is a major change from 2010 and one that investors are more likely to be impacted by than the attention grabbing change in leadership in Egypt.
There will be much discussion in the coming days and weeks about who may become the new Egyptian president. However, as has been the case during transitions in Egypt over the past 60 years of military rule, the military is an institution that transcends the individual. Certainly, there will be a new president. But, just like The Who’s Roger Daltrey sang, “Meet the new boss. Same as the old boss.”
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