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"Reports that say that something hasn't happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns -- the ones we don't know we don't know.”

-Donald Rumsfeld

A few nights ago, I participated in a panel on CNBC’s The Kudlow Report to discuss the outlook for the U.S. equity markets.  Interestingly, my co-panelists were an actor, Tommy Belesis, who was featured in Wall Street II and Lee Munson, who is not an actor, at least professionally, but is a veritable Jim Carey wannabe.  Larry asked all three of us about Egypt and both of my co-panelists suggested the spread of democracy would be a great thing for the markets.  Call me a nerdy hockey player from Yale, but my response was a bit more nuanced.

Stepping back for a second, I tend to agree that the proliferation of democracy is a positive force in this world.  (Hopefully that goes without saying.)  From a pure geo-political risk perspective, there are very few examples of modern democracies going to war.   Thus, the more democracies there are globally, the more likely it is that there will be less armed conflict between nation states.  This is a positive when considering a risk premium to apply to certain equity markets.

As it relates specifically to Egypt, the view I articulated the other night is that the outcome is very uncertain.  We don’t know that this is the onset of flourishing democracies in the Middle East.  Further, we don’t know what the unintended consequences of a regime change in Egypt will be.  As Former Secretary of Defense Rumsfeld notes above, the outcome of this historic last month of protests in the Middle East is, at best, a “known unknown.”

The benefit in having our headquarters at the Taft Mansion on Yale’s Campus is more than just easy access to Yale Hockey games at historic Ingalls Rink, but also easy access to Yale’s academic engine.  To the last point, we are hosting a call at 10 a.m. for institutional subscribers and prospects with Yale Professor Charles Hill.  The title of the call is “Analyzing the Geopolitical Chessboard: Is This Checkmate for American Influence in the Middle East?” If you’d like to join us for the call, please ping sales at .

Rather than acting, we decided to bring in an expert to discuss the situation in the Middle East and North Africa.  Professor Hill teaches the Grand Strategy class at Yale, and is the former Chief of Staff of the State Department, an advisor to former Secretary of State George Shultz, and former Secretary-General of the United Nations Boutros Boutros-Ghali.  Needless to say, Professor Hill forgets more foreign policy strategy in a day than most of us will ever know.

Currently, the primary issue as it relates to U.S. foreign policy in the Middle East is centered on the future of Egypt, which has been a long standing ally of the United States in the region.   After the 1973 Arab-Israeli War, Egyptian foreign policy shifted under Anwar Sadat, who opted to pursue a peace process with Israel, which he believed was in the best long term interest of Egypt.  As a result, the U.S. has been a major sponsor of both military and economic aid to Egypt.  In fact, Egypt is the second largest non-NATO recipient of military aid from the United States after Israel.

From an economic perspective, Egypt is the 27th largest economy in the world and, perhaps more importantly, controls the Suez Canal, which connects the Mediterranean and Red Seas.  The key benefit of the Suez Canal from a global economic perspective is that it allows water transportation from Asia to Europe without the need to circumvent Africa.  In aggregate, the Suez Canal carries almost 8% of the world’s sea trade.

Egypt’s strategic and economic importance can obviously not be understated in global affairs, and whilst it is difficult not to support popular protests against a non-Democratic regime, such as the one run by Hosni Mubarak in Egypt, as risk managers we also need to understand the alternatives.  If Mubarak was nothing else, he was a strong American ally in the region.

The debate over the future of Egypt currently centers on the role in which the Muslim Brotherhood will play.  The Muslim Brotherhood is the world’s largest and oldest Islamic political group, and was actually founded in Egypt in 1928.  Currently, the Brotherhood is banned in Egypt, but in the post-Mubarak era, the Brotherhood will have a role which could shift Egyptian foreign policy quite dramatically.  In fact, a leading member of the Muslim Brotherhood, Muhammad Ghannem, recently said to the Arab Press, “The people should be prepared for war against Israel.”

There are some that believe the Muslim Brotherhood is an effectual organization.  This was best articulated by Scott Atran, author of "Talking to the Enemy: Faith, Brotherhood and the (Un)making of Terrorists", in the New York Times yesterday when he wrote:

“Ever since its founding in 1928 as a rival to Western-inspired nationalist movements that had failed to free Egypt from foreign powers, the Muslim Brotherhood has tried to revive Islamic power. Yet in 83 years it has botched every opportunity.”

On the other side of the debate is Dr. George Friedman from STRATFOR who recently wrote:

“The demonstrations open the door for the Muslim Brotherhood, which is stronger than others may believe. They might keep the demonstrations going after Hosni leaves, and radicalize the streets to force regime change. It could also be the Muslim Brotherhood organizing quietly. Whoever it is, they are lying low, trying to make themselves look weaker than they are — while letting the liberals undermine the regime, generate anti-Mubarak feeling in the West, and pave the way for whatever it is they are planning.”

As for where Hedgeye stands, we covered our short Egypt position yesterday (via the etf EGPT) in our Virtual Portfolio.

Keep your head up and stick on the ice,

Daryl G. Jones

Managing Director

Known Unknowns - mass