El-Erian: Stock Market Sell off Is Not 1998 or 2008
Stock-Markets / Stock Markets 2015 Aug 25, 2015 - 03:34 AM GMTBy: Bloomberg
Mohamed El-Erian, former CEO of Pimco and columnist for Bloomberg View, spoke with Bloomberg TV's Olivia Sterns and Alix Steel about the selloff in stocks and the implications for Fed policy.
When asked whether we are looking at another 1998, El-Erian said: "I'm not a buyer that this is 1998. Nor am I am a buyer that that's 2008. And in 1998 you had a lot of fixed exchange rates. Now you have fewer of those. And 2008 was about the payments and settlement system. This is not about the payments and settlement system. This is an old-fashioned repricing of two things."
He added: "I'm not a buyer that this is the crisis of all crises. Yes, this is a very unpleasant repricing, very unpleasant. And it's going to go quite deep, but it's not going to derail the economy in a major way."
El-Erian said he believes a December rate hike is still possible: "I think December is still on the table, and for the following reason. The economy will benefit from lower commodity prices, particularly oi. And the economy will benefit from lower interest rates. And that's going to fuel some underlying strength that the economy does have. The big question is how much damage are we doing to the wealth effect, and to what extent will external demand collapse? We cannot answer that question yet. So I would think December is still a possibility, but September is unlikely to happen."
OLIVIA STERNS: All right. For more on whether this market turbulence will impact the Fed's thinking, I want to bring in Mohamed El-Erian. He is a Bloomberg View columnist and a chief economic advisor at Allianz. Mohamed, great to see you. Thank you for joining us. Does all the market volatility we are seeing today, does it take a September rate hike off the table?
MOHAMED EL-ERIAN: It certainly reduces the probability significantly, and understandably so. If this volatility continues, which it will, then the Fed will be very cautious. It will not want to fuel further volatility. And in such circumstances, it will most likely wait and not initiate the interest cycle in September.
ALIX STEEL: So when do you think, Mohamed, that it will happen? And Barclays now moved out their forecast to March of 2016 from September 2015. What's your call?
EL-ERIAN: So I think December is still on the table, and for the following reason. The economy will benefit from lower commodity prices, particularly oi. And the economy will benefit from lower interest rates. And that's going to fuel some underlying strength that the economy does have. The big question is how much damage are we doing to the wealth effect, and to what extent will external demand collapse? We cannot answer that question yet. So I would think December is still a possibility, but September is unlikely to happen.
STERNS: Wow. That's interesting, Alex. Ellen Zentner over at Morgan Stanley, she brought forward her rate hike call. I wonder if she is regretting that now. Mohamed, you said earlier this morning that the selloff, which by the way is picking up momentum throughout this interview, the Dow is back down I believe about 600 points right now, that the selloff will turn around once there is a policy circuit breaker put in place. What would that look like? What would government intervention have to look like to stabilize markets?
EL-ERIAN: So it's very important to understand that without an external anchor, this market will continue to sell off. And what you have seen today on very heavy volume and this amazing, almost 1,000 point range in fluctuation, is that there are still quite a few people stuck in overextended positions. And the buyers don't have that much conviction, and that's why we're selling off again towards the end of the session.
So we need that external anchor. Otherwise prices will have to go down a lot more to bring in buyers with conviction. What can that be? Unfortunately it's not the Fed, it's not the ECB. This one is different. The source of this dislocation is from the emerging world. And therefore what you need is something that stabilizes the emerging market over there. And that means China. So you need something credible out of China for that to act as your stabilizer.
STEEL: And what would the credibility look like? I mean we've seen the PBOC and the government intervene quite a lot within the stock market to try and prop it up. We've seen them try very different things when it tried to revitalize the government, like cutting the RRR, cutting reserve requirements. What would it be?
STERNS: And they've even devalued the currency.
EL-ERIAN: And well the devaluation of the currency, as I said at the time, was good in the medium-term, but was really bad in the short-term, because it added to the instability. The minute -- you have to understand the regime in which we've been in. The regime in which we've been in is of central banks repressing volatility.
The minute you have the currency markets in the emerging world doing crazy things, which they have been, it becomes very difficult to stop that volatility from spreading into the system. And that's exactly what has happened. The reason why I tell people to be cautious, because I don't think China can come up that easily with a solution overnight.
They face a very complicated situation. And financial markets are not the first thing on their radar screen. They have other things on their radar screen. So that's why this market is trying to find its own level, and therefore it's clearing at a much lower level than most people had expected.
STERNS: Mohamed, what's the why? What triggered all this selling effort, so many different explanations today, some people saying investors were just out over their skis on valuations, others saying there was a dislocation of the credit market, some macro explanations, oh this is what's going to happen into a rate hike, and then others saying, no, no, it's the volatility coming out of China. What do you tell people what caused this global selloff?
EL-ERIAN: So I just posted a column on Bloomberg View on this. Number one was the repricing of global growth. People recognized that China was weaker, and not just China, China, India, sorry, China, Brazil, Russia, Turkey, Indonesia. It's very hard to find one large systemically emerging economy, other than India that's not slowing down. So the first thing that happened is people priced in slower growth.
The second thing that happened is people realized that the policy response in the emerging world would lag -- would be lagging. And therefore they realized that you couldn't get a policy response fast enough.
Then, third, they realized that the Fed and the ECB had reduced ammunition, so they couldn't compensate for a problem elsewhere. The minute that started moving, then you get the typical deleveraging technicals. And that takes hold. People -- volatility goes up. They have to sell more. And then you get these technically-driven markets. And that's what we are right now. We're in a technically-driven market.
STEEL: Mohamed, though, the real concern seems to be are we looking at another 1998 where we saw Asian currencies think about a 41 percent. And take a look inside my Bloomberg terminal. This is a very long-term chart of the MSCI currency index. And that would require another 50 percent selloff in this index, so if we were going to match those 1999 levels. Do we see it?
EL-ERIAN: Yes. I'm not a buyer that this is 1998. Nor am I am a buyer that that's 2008. And in 1998 you had a lot of fixed exchange rates. Now you have fewer of those. And 2008 is about the -- was about the payments and settlement system. This is not about the payments and settlement system. This is an old-fashioned repricing of two things.
One is that growth is much slower than what people had anticipated, and secondly that policies are much less effective than what people anticipated. That is what we are repricing, and we will do so. And it will simply, you've seen my graph over and over again, it will bring financial asset prices towards fundamentals, and in cases we're going to overshoot, as is happening in some of the emerging countries.
STERNS: And, Mohamed, you have also been writing a lot about valuations recently, saying that valuations are out of whack with fundamentals. What do you think the multiple would be on the S&P if equities were fairly valued?
EL-ERIAN: So I think it would be a lot lower. I like to look at different companies. And what happened is a generalized increase in lots of different things. And that's been reversed in recent weeks. So I think the key thing for investors is to look for the following characteristics.
You want to be buying into companies and country with big balance sheet. You need resilience. Second, you need well-managed areas. And, third, you need to be in a forward-looking industry, not a backward-looking industry. There's value being created.
And I think active investors are going to get very excited once the smoke settles that there's lots of value being created. And there will be lots more value being created over the next few days.
STEEL: Mohamed, can you narrow that down for us in terms of sectors? I mean just you talking about it just reminded me of, say, tech. But is that what you're thinking when you describe what the value is?
So you see in new tech there's lots of opportunities being created in new tech. And they are much more -- there is a tremendous amount of cash on their balance sheets. Let's not forget that this -- corporate America has a lot of cash on its balance sheet. That's why I'm not a buyer that this is the crisis of all crises. Yes, this is a very unpleasant repricing, very unpleasant. And it's going to go quite deep, but it's not going to derail the economy in a major way.
STERNS: Mohamed, where are the opportunities in the credit markets right now?
EL-ERIAN: So you are going to see a major repricing of emerging market credits, of high yield and of investor -- investment grade. You're going to see the ability to finally get into good companies, especially in the investment grade space at more attractive yields. You are also going to see dividend-paying stocks being a lot more attractive.
And that's why I think that when we step back, and as long as you can navigate this incredible volatility -- you've heard me -- the last few weeks I was telling people be more barbelled. Take market -- take money out of public markets. Put a lot of it in cash, and some of it in venture, in these more illiquid opportunities that central banks haven't distorted, but be careful of the belly of the curve. Now the belly of the curve is starting to get more attractive.
STEEL: What are the negative knock-on effects, though, of the turmoil that we've seen? I mean there is so much money in emerging market bond funds, in places like PIMCO and Franklin Templeton. I mean what happens when those people say, you know what, I want to get out of here, and that spreads and there is no sort of bottom there? What's the trickle-down?
EL-ERIAN: So what's going to happen is what has always happened, which is that these asset classes will overshoot, creating long-term opportunities. Remember, these asset classes are dominated by what are called tourist investors, tourist dollars. They come in, crossing over from somewhere else, attracted by the yields.
They are being pushed into this asset class. And then when something goes wrong, like a tourist, immediately go to the airport. So what you see in these asset classes is typical overshoots on the way up, which we had, and now on the way down, which we are having.
And that is going to create opportunities. So, yes, those asset classes are going to be particularly badly hit. And we're all going to discover something that we've talked about in the past, which is the delusion of liquidity. There has been this belief that the markets can provide liquidity when the paradigm changes. And I think that we are discovering that that liquidity is not as forthcoming as many believed.
STERNS: Mohamed, what would have to change to make you bearish on EM?
EL-ERIAN: So what would make me really bearish on EM is if it turns out that these countries cannot respond and, importantly, if the West takes another leg down. So one thing we haven't talked about is that Europe is going to have to revise down its growth projections. The euro has been appreciating against the dollar, and particularly against emerging-market currencies. That's not very good for Europe right now. Europe is losing a source of external demand.
So I am worried -- I worry that the next, the next step, if you talk about the risk scenario, not the baseline, the new risk scenario, is that the weakness spills back into the advanced world, and then you get the vicious cycle. That is what people have got to be very careful. It's a risk scenario. It's not the baseline.
STERNS: All right. Thank you so much, Mohamed El-Erian, Bloomberg View columnist and the Chief Economic Advisor at Allianz, a prolific writer.
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