Don’t take a punt on Egypt – it’s not worth the risk

Egyptian stocks are looking cheap. But while forthcoming elections could give them a boost, they could also send the country into chaos. It's not a risk worth taking, says Matthew Partridge.

Last year's Arab Spring' took the world by surprise. The first leader to be swept from power was Ben Ali in Tunisia. That could have been dismissed as a one-off. But when Egypt's Hosni Mubarak fell soon afterwards, it became clear that the region would never be the same again.

Egypt has since dropped out of the headlines, replaced by the violence in Syria and Bahrain. But things are about to get dramatic again. Presidential elections are due at the end of next month and, unlike previous contests, no one knows the outcome.

The markets are similarly confused. While the Egyptian stock market collapsed after Mubarak's exit, it has recently rallied. To try to get a handle on the situation, I've been in contact with John McCreary, chief analysis officer of KGS (Kforce Government Solutions).

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Mr McCreary, who previously produced analysis for the chairman of the Joint Chiefs of Staff, is recognised as one of the top intelligence experts in the world. So what does he think will happen?

This is not an inspiring election for investors

With Mubarak gone, some pundits had hoped that a secular reformist would fill the gap.

Sadly, these- perhaps somewhat optimistic - hopes were quickly dashed. While protestors focused on further reform, the Islamists cut a deal with the temporary Supreme Council of the Armed Forces (SCAF).

So while many reformers ended up in jail, the Islamists were able to campaign. As a result, the two Islamist parties did well in last year's elections. They now control 358 of the 508 seats in parliament. This rises to nearly 400 when allies are added.

The other parties were fragmented and divided. This encouraged the Islamists to seek power directly. Initially the first two front-runners for president were the Muslim Brotherhood's Khairet El-Shater and the even more extreme Abu Ismail. This set up a three-way contest between the two Islamists and Omar Suleiman, Mubarak's former spy chief.

Then, a fortnight ago things were thrown into chaos. The election commission decided to banten candidates, including the three main frontrunners, from standing. The leading candidates are now former foreign minister Amr Moussa, Mohammed Morsi for the Muslim Brotherhood, and Aboul Fotouh.

At least two of them should worry investors.

As a former minister, Amr Moussa is well known. He is also relatively secular and liberal. However, McCreary predicts that he "will not change the system of patronage and crony capitalism". Currently quasi-state firms, run by the army, dominate the Egyptian economy, holding back growth. Moussa's hardline stance on Israel may also inflame tensions with the US, which provides a large amount of economic and military support.

The Brotherhood's Mohammed Mursi has promised to give clerics a say over policies. This is likely to lead to policies, for instance on alcohol, that will hit the tourism sector, a large part of Egypt's economy. According to McCreary, the Brotherhood's attempt to ban former regime candidates also suggests that they are going to govern like Mubarak. Mursi has also been critical of International Monetary Fund (IMF) aid for Egypt, which most experts agree is vital to prevent an economic crisis in the country.

So with these two, it's very much a case of "meet the new boss, same (or worse) as the old boss".

Of the three, Aboul Fotouh is the most interesting. Although he used to be a senior member of the Muslim Brotherhood, he split with it last year. His stated views are much more moderate than those of Mursi and he has wealthy backers. McCreary compares him to Turkish president Tayyip Erdogan, another pro-business Islamist.

However, his long involvement with the Brotherhood, and his links to the ultra-hardline Yousef al-Qaradawi, suggests that there are limits to his moderation.

The worst-case scenario for Egypt could be civil war

In other words, none of these candidates sound especially promising for the Egyptian economy.

So who will win? Opinion polls suggest that Moussa is currently in the lead. Yet even if they are correct, he is far short of a majority, so the election will have to go to a second round. This means that things probably won't be settled until June.

In any case, McCreary thinks that any surveys need to be taken with a pinch of salt. Sampling problems mean that they are of limited use in predicting how people outside Cairo will vote. And given the parliamentary results, Mursi only needs to stop the Islamist vote from splitting to win. With Abu Ismail's former supporters on board, he could get up to two-thirds of the vote in a run-off.

Already many prominent hardline clerics have started to endorse Mursi. This suggests that his opponents do not have a chance "unless the Army engineers the outcome". Of course, recent events mean that army interference can't be ruled out. However, this could lead to a huge backlash.

One nightmare scenario is a repeat of Algeria. In 1992, Islamists won power in elections. The military didn't like the result, so they mounted a coup, which quickly turned into a civil war. Although the Islamists would find it difficult to deal with the military's firepower, they could try and get external support. In the worst case, Iran could help out. This would "really send the Saudis into orbit".

Of course, things are unlikely to go this far. While Algeria is "a useful analogy for what might ensue" in the very worst case, McCreary does not think that there will be civil war. However, he sees "prolonged instability" instead. Because, even if they lose, "Islamists will return to Tahrir for large scale demonstrations".

Best to avoid Egypt

The Market Vectors Egypt Index ETF (US: EGPT) is 40% below the level it was18 months ago. If the next president delivers at least some reform, keeps Egypt stable and maintains US and IMF aid, then it is likely to go up sharply.

However, while there is a chance that this could take place, Egypt faces a Hobson's choice between the corrupt status quo with Amr Moussa and an Islamist state that could scare away tourists (and investors). There is also a very high chance of post-election unrest.

So although Egypt is too cheap to recommend going short just now, it's also far too risky for us to suggest going long. Just steer well clear for now.

The same can be said for companies operating in the region - like Centamin Egypt (LSE: CEY). The share price of the gold miner is now only at athird of its two-year peak. However, it is heavily dependent on government support for fuel prices, which is being phased out. Production has already been hit by labour problems. Therefore it is unlikely to recover soon and could get worse.

Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri