No doubt ‘there is massive risk-taking going on’: El-Erian
Mohamed El-Erian, President of Queens' College University of Cambridge, joins Yahoo Finance Live to discuss markets, the economy, President-elect Joe Biden and what risks investors face in the event of another market downdraft.
- Just start with big picture, what we've seen play out over the last several months. The market at least seems to be looking past a lot of this short-term pain. They seem to be very enthusiastic. How are you balancing the news and the skyrocketing COVID cases with the vaccine progress that we've seen over the past three weeks?
MOHAMED EL-ERIAN: So I think it's really good news that we had all this vaccine progress, which is not just more vaccines, but logistically easier vaccines, which means easier adoption. So that's good news. And that means that the destination, the light there is shining a lot brighter.
The journey has had also a few-- a little bit of help. We've had clarity of political transition. We've had clarity about appointments. And we've had-- we have clarity that both the ECB and the Fed will do more.
So I can see why the market has embraced the better destination and has embraced this improvement in the journey. But we still have quite a bumpy journey left. And I suspect we're going to see unfortunately some companies come under a lot of pressure in the next few months.
- You know, Mohammed, you've mentioned monetary policy there. And we've certainly seen a re-emergence of the potency of fiscal policy-- something that, you know, you and others have been discussing for many years. But are you concerned now that politicians not just in the US, but globally are sort of losing their will to use that forceful fiscal tool, that lever they pushed on finally back in the spring? And does that set us up for some disappointments next year?
MOHAMED EL-ERIAN: So certainly, they have lost their will. If you look at the US, and the US is a good example because we have ability. But what we've lost is willingness. Not so in the UK, not so in parts of Europe.
So in the US, yes, we have lost our will. I suspect that that will be reversed after January 20 where we will find our will again. The problem is that we create a lot of damage in the interim.
- Mohammed, talking about some of that damage, I think a lot of the questions at least now over the next month or so are these COVID relief programs that are set to expire, that fiscal help that we've seen in the economy, the unemployment insurance expansions, eviction moratoriums. How big of a risk do you see this being to the economy, at least in the short term?
MOHAMED EL-ERIAN: It is a risk, and I think we're seeing it already. This economy has slowed down. There are already indication that the labor market may be going into reverse, which is problematic.
We have more restrictions coming, more COVID-related restrictions coming because of what you've been talking about earlier, hospitalizations going up. So yes, we are slowing. And we will slow more to the extent that household economic insecurity goes up. And that's not just a short-term issue. When economists talk about scarring, which means a longer term damage to the economy, they are referring both to the demand side, financial insecurity, and also to the supply side. So it is an issue.
- And do you think, Mohammed, if we go back to the last recovery where I mean, we had a sequester in 2013, right, which kind of seems crazy in hindsight. Are you concerned that we will fall into those same habits, at least here in the US? And you can already see some Republicans talking about the need to manage the debt and so on. These talking points are coming back quite quickly.
MOHAMED EL-ERIAN: They are. And remember, reacted in March all over the world to the COVID shock, which was an economic sudden stop. We acted, thinking it was in game theory terms, a one-round game. Throw everything at it, all in.
You're going all in like a final hand in poker, and you've got to fix it. And in the back of our head was this notion of the global financial crisis. And what we've discovered is financial counterparty risk-- what we had in 2008-- is easier to solve than human counterparty risk-- me and you not trusting each other's health.
So what started out as a one-round policy response has had to evolve into a multi-round policy response. And that's where it gets problematic. So I think there's good reason why you're seeing the Republicans push back, saying, hey, wait a minute. I didn't sign up for a multi-round fiscal reaction. I signed that-- signed that for what? But I do think we're still going to see a fiscal package emerge after January.
JARED BLIKRE: Hi, Mohamed. Jeffrey Blikre here. I want to get your take on the markets maybe having gotten a little bit ahead of themselves. You look at positioning. We've seen incredible flows into global equities around the world and also complacency, too.
We just saw the VIX today dip below 20 for the first time since the highs that we saw in February in the market. So what kind of risks are there for investors to maybe another sudden downdraft? And how big might that be if it came to fruition?
MOHAMED EL-ERIAN: So there's no doubt in my mind there is massive risk taking going on. I can keep you for the next hour, giving you example after example. Peru issuing a 100-year bond. Peru has had three presidents in the last few months, has great political instability, and yet is able to issue 100-year bond at very low spreads.
I can take to areas of the ETF. I can take it to areas of high yield. Yes, there was a lot of risk taking going on. And the reason why is the mindset. As long as we believe that there's a vaccine, and as long as we believe the central banks are going to minimize all the damage to the markets, not to the economy, to the markets up to that point, what you will get is people stretching for more returns.
Now, that works well, except in one case, bankruptcies. And I tell investors, please be careful. Do another granular analysis because as you stretch for more yield, you take on a lot more default and bankruptcy risk. And that is not something that central banks can save you from.
- Mohammed, I want to ask you about a recent op-ed that you had in the FT. And you discussed why President-elect-- or why you think President-elect Joe Biden needs to break the market's co-dependency with the White House. And you talk about the Trump administration's direct ties with the markets, the fact that the president has routinely cited the market's performance as success for his administration. Why do you see this as a necessary step? And what do you think the Biden administration needs to do in order to break that co-dependency?
MOHAMED EL-ERIAN: So it's a problem because we have decoupled finance from the economy excessively. The gap between Main Street and Wall Street is very, very large, and it is increasing. And that's not healthy for society, and it's not healthy for the markets longer term.
You should worry about a reckoning longer term, especially if the economy doesn't improve quickly and validate what are very high asset crisis. So we need to minimize that risk that there's going to be a significant weakening down the road that causes not just financial instability, but also economic instability. And part of that decoupling has been the notion that the market is protected.
It's protected by the central bank, and it's protected by the White House because the White House m-- it takes to markets as a measurement of how well it is doing, which is not-- which is not true, by the way. The market is not the economy.
So President-elect Biden has an opportunity to make that clear by taking the focus away from the marketplace, one. And two, he's got some really important appointments to make to the board. So that's going to be looked at really carefully. And the inclination will be to do what has happened before.
And it's not just him. I'll cite you General Powell. I'll site you Christine Lagarde. Both of them tried to reduce the co-dependency. And the market responded so badly that they had to U-turn. In the case of Madame Lagarde's comments on Italy, it happened within days.
- And Jerome Powell, I suppose, only a couple of months after that last rate hike beginning the patient cycle. But I want to ask about one of those appointments. Of course, Janet Yellen, likely be the next Treasury Secretary here in the US. And how that maybe shapes your view on an administration that is, at least, thinking about viewing financial markets just as something that exists rather than a tool of the administration itself.
MOHAMED EL-ERIAN: So I cannot think of any appointment that has triggered as much support as that of Janet Yellen. The economists, politicians from both sides, market participants, everybody welcome that appointment and for good reason.
She has a very strong academic foundation. She has a ton of experience. She's viewed as being of a stable hand. And she brings to Treasury something that I think everybody appreciates is needed, which is close fiscal and monetary coordination and close-- or closer or some-- let's call it some because we started from such a low point-- global policy coordination.
So that's why her appointment has been so welcomed by so many. And I think what you're going to see is just better policy coordination across the world. And that's a positive thing. What she can do domestically will depend on what happens in Georgia.
I mean, let's not forget that we still have important Senate elections coming up. And that would have a very important determinant on how much flexibility this administration has.
- Mohammed, just going back to your comment earlier just about the economy, I want to specifically ask you about what we've seen play out in the labor market. Because I think the labor market recovered much quicker than many economists were expecting. But over the last two weeks, we've seen the number of jobless claims rise for two weeks in a row. And it's already-- it's coming off of what is historically an extremely high number. What is this signaling to you just in terms of the fact that maybe some of the progress that we've made recently is starting to unravel?
MOHAMED EL-ERIAN: It's exactly that. I mean, you're right. We started-- we stopped improving at around 700,000 initial claims on a weekly basis. And now we're almost had 800,000. And that's way too high a number what is stage of the recovery.
So we are seeing the recovery be a lot less not just compared to what's needed, but also what's possible. And that's a major concern. That's why you've got to think about the journey as well as the destination. And the destination is going to be a function of the journey.
And if we don't get a policy response both on the supply and the demand side that's forward looking, we may find out that the journey is very painful for more households and more companies, and the destination has more scarring. That's why the policy response come January is going to be so important.
- Mohammed, it's been a challenging year for markets and the economy around the world, but perhaps no organization more challenged than the New York Jets right now. I would love to finish up with your thoughts on what is happening there as a long beleaguered fan. How can-- how are you making sense of what's happening there?
MOHAMED EL-ERIAN: So I don't even put my handkerchief away because I just-- I now have it outside. It's so sad. And you know, I go through the same cycle everybody else goes.
You know, last Sunday, I actually started believing that they were kind of rally and win, only to see them lose. Look, they need a major, major revamp. I'm talking major. It is not changing a few players, changing a few coaches. This is an organization that is in desperate need of a revamp.