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What impact should Egypt have on your investing decisions?

The answer is not much, unless you believe you have particularly good insight into Middle East affairs. My rationale is that Egypt accounts for a small portion of the world economy and, more importantly, that the events unfolding are unpredictable.

Egypt's economy generated about $200 billion in 2010, a small enough size not to disrupt global growth. It is also small enough not to account for a significant position in most international funds. For example, the country comprises just 9.3% of T. Rowe Price’s Africa & Middle East Fund (TRAMX). The only way to get direct exposure is to specifically seek it out by investing in a fund like Market Vectors Egypt Index ETF (NYSEARCA:EGPT). I will have more to say about the ETF in few paragraphs.

The economic danger from Egypt extends beyond its borders, of course. The Suez Canal is a major shipping canal with more than 2% of global oil output passing through it. Political instability could put neighboring countries on edge, particularly Israel. There is also the possibility of political unrest spreading into other Middle East countries. Any significant disruption to oil production, or perceived threat of one, would likely send energy prices higher.

Forecasting such events is next to impossible. A few weeks ago, the mere suggestion of Tunisia's government being overthrown would have drawn laughter from Middle East experts. Now, Hosni Mubarak's future is uncertain, Jordan is reshuffling its government and Yemen's president does not intend to serve out his full term. It's a guess as to whether the unrest will spread elsewhere.

So far, the world's major financial markets have acted as if no significant instability is forthcoming. The markets are never right or wrong; they simply reflect the consensus analysis of valuations and expectations for future profits at a given point in time. The consensus is currently saying political instability in the Middle East won't cause a global economic disruption.

Could this change? Absolutely, but it is difficult to trade ahead of such a shift in sentiment. An investment in oil futures and perhaps gold would provide a hedge, but if the governmental transitions turn out to be peaceful, you lose both dollars invested in the hedge and the opportunity cost of not investing your money elsewhere.

Plus, any future market weakness may simply be caused by the fact that stocks have moved steadily higher since September. The Middle East might get blamed, but stocks (or other assets) never move in one direction for an extended period without interruption. In other words, a pullback will occur sooner or later regardless of what happens in Egypt and elsewhere in the Middle East.

Ultimately, you have to position your portfolio in a way that both helps you achieve your financial goals and allows you to sleep at night. Be careful not to make reactive decisions based on the headlines, but also be sure to keep your risk exposure at a level that you are comfortable with.

THE ODDITY OF MARKET VECTORS EGYPT INDEX ETF

During the political turmoil, the Egyptian stock exchange has been closed. The Egyptian economy has also incurred disruptions as banks have also been closed and ATMs are out of cash. Given this, it would only be logical that investors would be wary of acquiring an Egyptian fund. Particularly one that "provides exposure to publicly traded companies that are domiciled and are primarily listed on an exchange in Egypt or that generate at least 50% of their revenues in Egypt."

Yet since January 26, volume in EGPT has exceeded 700,000 shares per day; more than 10 times the fund's three-month average daily trading activity. Mass selling is not behind the increased volume either. Shares rose to nearly a two-week high of $19.14 on Tuesday, before pulling back. This morning, EGPT was trading at $17.91, less than 5% below where it was trading on January 25.

It gets even more absurd. The fund's net asset value (NAV) is $16; the per share value of EGPT's underlying assets. This means investors are currently paying an 11% premium to invest in Egypt. (A representative for the fund told me that an NAV is being updated based on a fair value methodology, since the Egyptian stock exchange has been closed for several days.) Given the ongoing turmoil, one would think that investors would not be willing to pay a premium to invest in Egypt.

This is a case of investors, and more likely traders, ignoring the risks and chasing after whatever security is currently moving on a given day. It is not a strategy for success, as many will inevitably be left holding the proverbial hot potato.

Rather, a successful strategy would be to follow the Nine Timeless Rules for Investing in Mutual Funds (and ETFs) outlined by former AAII President John Markese.

Source: Egypt's Impact on Your Portfolio Strategy