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Anti-government protests in Egypt reached a fevered pitch in Cairo on Friday as demonstrators were demanding an end to the thirty year rule of incumbent President Hosni Mubarak, who is now 82 years old.  At the core of the protests are frustrations over high rates of unemployment, rampant inflation (Ex. rising food prices) and increasing poverty levels across this Middle East country.  These frustrations have been percolating over the past few years but have intensified over preceding weeks.

Many suggest that the recent uprising in another Middle East country; Tunisia, which resulted in the Tunisian President being removed from office, may have given the Egyptians the courage and conviction to attempt their own government overhaul.

These actions have led to great uncertainty with respect to what the potential implications may be not only in Egypt but for the entire Middle East region as well.   Here are the potential implications as we see them:

• The first major potential implication would be the risk of contagion in the Middle East and the civil, political and economic unrest that could result across the globe.   With respect to the latter, consider that according to the U.S. Energy Information Administration (EIA), the Middle East still accounts for close to 26% of the world’s total oil production.  Hence, any turbulence in some of larger oil producing countries (Ex. Saudi Arabia and Iran) in the region could have ripple effects into a global economy that is still very dependent on crude oil to satisfy its lifestyle needs.  If oil supply is reduced as a result of the turmoil in the region and the demand for oil does not decrease by a similar magnitude, oil prices will most certainly have to increase.  Rising oil prices could impede the global economic recovery which is still in its nascent stages.
• Following on the above, the second major potential implication that we see is also found in the energy commodities sector, specifically related to crude oil prices, but this time not based upon oil production but rather based upon the importance of the Suez Canal (which connects the Red Sea to the Mediterranean Sea) and the Sumed Pipeline (also known as the Suez-Mediterranean pipeline) from an oil transportation standpoint in the region.  While Egypt is not a large producer of oil, it is strategically important due to its role as a transportation conduit.
• The last area of potential implication that we see would have to be the travel sector given the travel advisories that will likely be established in the affected countries and the weariness of individuals to travel to these countries as a result of the violence.

We, at Hennion & Walsh, believe that these events should remind investors of the exogenous risks that exist in the stock market from a geopolitical perspective.  These risks, while they may be on the radar screens of certain economists, often come to the surface quickly and without warning.  It should also be noted that Egypt is classified by some as a “Frontier Market”, or, put differently, as an “emerging, Emerging Market”, and emerging markets possess their own unique set of risks that should be carefully analyzed and understood before considering an investment in this asset class.

The current situation in Egypt is yet another real world example of the need for diversification within a long-term investment strategy to help withstand varying periods of heightened market volatility.