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February 2011 Investment Journal 

What an amazing month for history buffs! While the markets provided their normal and steady stream of "thrusts and parries", the tectonic plates were shifting in North Africa and the Middle East, setting in motion changes that have been decades in the making. Oil rose stepwise with the fear factor, and gold resumed its upward march as a safe haven beneficiary. Stock markets generally rose in developed countries, but fell off in emerging markets. Bonds rallied, and the US dollar weakened.
What began in Tunisia and Egypt has now germinated into a full fledged uprising against entrenched power. The salient points for investors have both short and long term implications. Clearly, in the short term oil production and supply have been adversely affected, causing many energy related investments to benefit. Saudi Arabia has announced they will step in to fill the void, but many are questioning their ability to act as "swing" producer. Only time will tell. Meanwhile, any technology or service that enables or improves the finding, extraction, transportation and processing of oil will benefit.
The longer term effects are less clear. The poor, young, brutalized and impoverished citizens of those countries have had enough, and technology now makes it easier than ever to organize, evade, and disseminate information (including photos and video clips). There is a huge divide, however, between West and East (we don't see, for instance, any images of women protesting in the squares nor are they spokespeople or "leading" voices). Democracy seems to have a different meaning in that part of the world, and, given the U.S. support for the status quo over so many long years, its' American flavor is not likely to be savored. Unfortunately, markets are in for some more rattling as hardliners push back, especially if more vital oil interests are affected (the Persian Gulf especially). (Let's also not forget that Nigeria is in a state of flux, and that premium grade Bonny Light oil supply there is subject to constant disruptions.) We have long advocated owning energy stocks with lots of secure reserves in stable countries, and now is the time for them to shine.
Iran is likely to be the primary beneficiary of the current turmoil, as Shiite populations everywhere find in them their natural champion. (What exquisite irony it would be if the Persian people side with the voices of dissent and topple the mullahs of Tehran?) China and Russia stand to benefit also, both from their relative antipathy towards the U.S., and the vast resources they can bring to entice some changes (Russia especially will become more assertive in direct proportion to their surging oil and gas revenues). We would not be at all surprised to see an offer to locate new Russian or Chinese military facilities in some warm water port to "balance" the region as national interests and relationships are re-appraised. (As we write this, Turkey has announced that any NATO military action against Libya would be "absurd".)  It looks to us like a new military build-up is in the cards throughout the region.
Technology is also a strong beneficiary, as the "real time" enablement of dissent and action has been vividly proven. (We wonder though how events will turn if the hackers manage to post a credible "mock" video to inflame the "oppressed" - such as a "purported" assassination of an Arab leader by an Israeli agent? This is among the top risks mentioned by cyber-warfare experts and intelligence analysts.)
The other landmark historical and market-related event in February was the rousing victory of the Fine Gael party in Ireland on Feb. 25, turning out the entrenched Fianna Fail party which has dominated Irish politics for decades -- until they sold the country down the river last fall in exchange for an EU bailout of their banks. This is a game-changing event. Just a week earlier, the head of the German Bundesbank Axel Weber resigned his post in protest at what his government was contemplating (guaranteeing more bad debt from hemorrhaging EU partners). (Weber was considered Germany's last best hope for defending the country's financial strength as the front runner to lead the European Central Bank.) At the same moment, Germany's voters threw out the ruling CDU party of Chancellor Angela Merkel in Hamburg, again in protest at using their money to bail out debtors. (The CDU wasn't just defeated, they were humiliated, slipping to just 21% of the votes, versus 43% in the last election.)
Now, the Irish are poised to say "stuff it", and they will refuse to sacrifice literally decades of sub-par growth ahead so private investors in senior bank bonds (including almost all of Europe's leading investment banks) can be paid off at par. We don't know how or when a re-pricing of risk will occur, but it will and it must, as the insanity of adding more debt to impossible repayment obligations becomes clear to all. The EU is in going to demonstrate in real time the dynamics of taxpayer revolt in the developed world. This issue is going to re-emerge over the next several months as Portugal flounders and Fine Gael demands renegotiation of the penurious bailout terms imposed on Ireland by the EU. It is going to be an interesting spring.
Lastly, the U.S. is having its own mini-version of revolt in Madison, Wisconsin as the Governor there seeks to inhibit the negotiating power of unions. Ultimately, all public sector workers in the 50 states are going to discover that rich benefits and pensions negotiated in a different time and place don't square with the math required in the Age of Austerity that always accompanies a grand scale debt de-leveraging. If the private sector has been and will continue to have to "downsize and right-size", there is no way the public sector literally gets a free lunch. The numbers don't add up, and voters here, like in Ireland, are only getting started on the push-back.
Elsewhere, the trend of divergence in equity performance between emerging markets versus developed markets accelerated in February, and will bear watching. India is struggling with a nasty corruption scandal in their telecoms ministry, and their central bank is raising rates to fend off inflation (seems like a lot of bad news is priced in though to us.) China recently announced that they are going to slow their GDP growth target from 9% per annum to 7%, so the "command" style economy is going to develop new patterns which are as yet unknown. Our early take is that demand "pull" will continue as their need for modernization is inextricably tied to preserving social harmony, and the events in the Mid-East only serve to underscore their deliberate need for speed.

As always, thank you for reading our Journal.  

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