Mohamed El-Erian: The Three-Speed Global Economy
Possible U.S. Recovery
The U.S. is also heading to a T-juncture, though it lies farther in the future than Europe’s, El-Erian said, and its choices are much less severe. The U.S. is “healing,” he said. Corporations are strong, banks are mostly repaired, the housing market has stabilized and household finances are improving.
The Federal Reserve will dictate which direction the U.S. takes. It must decide when to disengage from its current monetary policies of zero interest rates, aggressive forward guidance and quantitative easing. One path, El-Erian said, would lead from assisted to self-sustaining growth, fueled partly by the energy revolution in technologies such as hydraulic fracturing, known as fracking.
The other path, however, would be one dominated by structural unemployment. El-Erian said he’s not convinced that long-term unemployment or the joblessness facing the younger generation has been adequately addressed. “If it turns out that the structural side is problematic,” he said, “the healthy balance sheets will not engage, and the energy revolution and newer technologies will be sector stories.”
The emerging markets face a much longer road than either Europe or the U.S. These countries face the choice between transitioning to consumer-based economies or continuing to rely on export-driven growth.
To answer the broader question of global growth prospects, El-Erian cited Tom Friedman, the New York Times columnist. Friedman has written that the world is not just interconnected; it is interdependent. In such an environment, one’s competitors become one’s friends, and those relationships shape macroeconomic growth prospects.
“We cannot afford for China, our biggest competitor, to stumble,” El-Erian said. The same is true of Europe. The U.S. relies on those economies to purchase securities and supply imported goods, and recessions there will impact U.S. growth.
But policy coordination at the global level has been “virtually nonexistent,” he said, and bank regulation is taking divergent paths. The challenge now is that major developed markets are weak, El-Erian said, and nobody is stepping in to stabilize the global economy.
El-Erian outlined six takeaways for investors.
“Ride the central bank wave:” Central banks are creating liquidity by engaging in quantitative easing, and those policies are likely to continue, El-Erian said. He did not explicitly say what he meant by “riding the wave,” but the implication was that investors should hold riskier assets, like equities.
He warned, however, that it is a “crowded wave” and that it will break at some point, either smoothly or abruptly. Investors will need to accurately anticipate central bank decisions. He said that PIMCO has been pursuing this path, but the likelihood is that riskier investments will get more costly and riskier, increasing the probability that the wave will break badly.
- Take advantage of other waves that are less affected by central bank actions: Opportunities exist, for example, with small companies, which are insulated from Fed policy.
- Don’t be held hostage to benchmarks that may have made sense previously, but don’t in today’s markets: “Advanced economies are not just vulnerable to interest rate risk. You are being haircut every day, including through financial repression,” he said. “The emerging world is not simply credit risk anymore. It is a much more diverse opportunity set.”
- Recognize that “beta is simply not going to be there anymore:” Prices are approaching levels where investors are hoping the fundamentals will validate central bank actions, El-Erian said. He said there is a limit to how far investors can expect overall market movements to benefit them. “That is another way of saying alpha is going to have to do a lot more of the heavy lifting for you than beta,” he said.
- Keep liquid : With economies approaching T-junctures, investors should remain flexible. “If it happens that we go the bad way,” he said, “you will get loss of assets very cheap.”
- Consider cost-effective tail hedging, especially now that volatility is at an enormously low level: Risk mitigation strategies are going to evolve, El-Erian said.
“Maintain as much operational agility as possible,” he said. “Make sure you have a good dose of resilience on top of that.”