Can Egypt Take the World's Markets Down?

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Includes: DIA, EGPT, EGYP, QQQ, RWM, SPY
by: Joseph L. Shaefer

And, of course, the other side of that coin: If events are resolved without a further escalation in violence in Egypt, are the US and other markets ready to resume their ever-upward trend?

My short answer is: No. To both.

Speaking first to the internal Egyptian (and greater regional) situation as a geopolitical analyst, then to world markets as a financial analyst, let me define why I believe this to be true.

Mubarak is gone. My best guess is that it is already a Done Deal, but just hasn’t yet been announced as to the “how” of his leaving. “When” is likely to be sooner rather than later, probably within the week, and “where to” is likely to be those less-than-fertile grounds where so many geriatric former dictators go to find succor and comfort, Saudi Arabia.

When the US Secretary of State is asked what Mubarak’s fate will be and she responds, as coached by her own geopolitical lieutenants, that the US is not seeking “any specific outcome,” that the US stands “ready to help with the kind of transition that will lead to greater political and economic freedom,” and Mubarak’s future is “up to the Egyptian people,” that’s Foggy Bottom code for “We’ve given up on the increasingly out-of-touch old boy and are dismayed by his attempts, North Korean style, to ensure that his son succeeds him. As long as the Muslim Brotherhood (MB) or some more radical group doesn’t have the juice in-country to establish an Islamic theocracy, we figure anything will be better than the pressure cooker that is Egypt and the pressure cooker lid that is Mubarak.”

As I wrote in a comment elsewhere on SA, Egypt, by Nasserian decree, has been a secular nation too long for the MB or worse to step into the vacuum unopposed. My guess is that the military (which, as in Turkey, has long been the guarantor of stability and, like Turkey, is seen as apolitical in defense of the nation) is at this moment arranging for Mubarak to live his remaining days in Saudi Arabia, safe from the contempt or worse of his fellow citizens, while they work to find candidates who will satisfy the electorate for at least a honeymoon period of a year or so. How they perform during that time will determine what happens from 2012 forward.

It is in great part because of Nasser’s socialist secularism that the Egyptian educated and middle classes might pay the occasional lip service to radical jihadism but actually prefer a more pragmatic form of social or socialist democracy. Even the poor have been raised to believe that Egypt is different – not merely part of the greater Islamic pale. They’d rather complain about their form of government but turn the current slate out every now and again than radically change their form of government to something like what Iran has. (As would the poor and middle classes in today’s Iran, as well, but that’s another story…)

Saudi Arabia’s King Abdullah and Crown Prince Sultan will spend every dime in the US Treasury and maybe even part with a few of their own to ensure that such a regime change doesn’t take place.

The US has made no particular friends during this fiasco. By supporting the status quo in Tunisia, in Egypt, in Yemen, in Saudi, et al, we are seen as defending regimes that are corrupt, nepotistic, hypocritical and barbaric in their treatment of their own citizens. It doesn't help that the empty tear gas canisters and shotgun shells littering the streets of Cairo say "Made in USA" on them. That’s a result of the fact that, of the $1.6 billion foreclosed-upon American taxpayers ponied up to give Egypt last year, $1.3 billion of it allegedly went to Egypt’s military to ensure the continued safety of the nation and its inhabitants. But in fact, Mubarak determined that “military” also meant paramilitary and the hated police and Central Security Forces and dispensed these tools to them all.

Events in Egypt did not create an environment of panic in US and world markets. Events in Egypt simply precipitated the decline that was due. If it weren’t Egypt it would have been something else. And if Egypt disappears from page 1 in the coming days, I don’t believe the markets will magically turn around in the short term. Here’s what those “something elses” might be…

The first might be simple exhaustion. I wrote an article titled Seeking Alpha, Finding Zen describing the differences between secular bull and bear markets and the much shorter cyclical ones. Clearly, with the silly certainty of hindsight, we have been in a cyclical bull since March of 2009. (Which was not entirely unexpected: my article Can You Hear the Bell Signaling a Bottom? was published three days before the absolute low.) But this bull is tired. In India, in China, in Brazil and in the developed markets of the US and Western Europe, the markets have come so far from their 200-day moving averages that most have rolled over and already begun their decline. Only the US is still well above that point. We can’t have it both ways – either we are in a global economy where our fates are increasingly intertwined or we are not. If investors are moving to cash everywhere but here, maybe we should see if they presage our own retracement.

This cyclical move rose over 90% from March 2009 through Thursday. The average of all cyclical bulls, some higher and some lower, since 1932, has been 101.5%.

Second, the news front gives as many compelling excuses for a decline as did / does Egypt. Let’s see…

  • US home prices fell again. (Ultimately good news since that makes them more affordable and, unlike stocks, most of us aren’t about to sell our home just because prices are down.)
  • Unemployment claims surged by an unexpected 51,000 through mid-January. We need to put people to work as much as they do in Egypt or anywhere else!
  • GDP grew 3.2% in the 4th quarter, not as positive as most forecasts of somewhere around 4% growth.
  • Durable goods orders fell 2.5% compared to the consensus forecast that they would rise 1.5%.
  • Indian markets fell. Brazilian markets fell. Chinese markets continued to fall.
  • I see China possibly facing the kind of housing bubble we ourselves have grappled with for 3 years now.
  • And Europe is still The Sick Man of Europe.

Finally I offer this: Complacency is everywhere. Even a 166-point warning shot was met with, “Don’t worry. It’s only because of Egypt.” The American Association of Individual Investors poll and the Investors Intelligence poll of investment are both at extreme levels of bullishness / complacency that typically correlates with short-term market tops.

I’m not predicting some kind of double-dip here back to the depths of 2008-2009. Our economy has changed a great deal since then, and for the better. The fear of a huge tax boost (via the expiring Bush-era tax cuts) is gone. Housing is far more rationally priced and more affordable to more people. And if we can keep government from making it near impossible to run an entrepreneurial business, we will see many unemployed doing what Americans always do when they try to find a job and can’t: they’ll start their own damn business – and hire others as they grow.

I believe a decline back to the S&P 500 200-day moving average around 1175 would be enough to shake out much of the complacency and set up a good market for the rest of the year. In the interim, we are tightening our trailing stops on positions with large profits, adding stops to some additional ones, and are going to now purchase a small hedge position via the (unleveraged) ProShares Short Russell 2000 (RWM.)

Full Disclosure: We have trailing stops on about 60% of the positions in our portfolios – too numerous to recount. We have also initiated positions in RWM.

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