Why Markets Are Caught In a Tug-of-War
Mohamed El-Erian
President @ Queens' College, Cambridge | Finance, Economics Expert
This post originally appeared on Bloomberg View.
There is a simple way to explain the tug-of-war that played out in the equity markets yesterday, over the last few weeks and, indeed, for much of this year. And this simplicity sheds an interesting light on investment strategies that are likely to play a larger role in price determination going forward.
Equity markets spent most of yesterday pushed and pulled by two opposing forces.
Stocks were pushed higher by better-than-expected corporate earnings, stepped-up mergers-and-acquisitions activity, and the continued comforting support of friendly central banks (particularly, the U.S. Federal Reserve and the European Central Bank). Moreover, as confirmed by the most recent data, the U.S. and, to a lesser extent, European economies are strengthening.
It helps that many professional investors have believed -- and quite a few still do (though see the qualification below) -- that climbing stock prices are magnets for increased interest from retail investors who have stayed on the sidelines. The same professionals also consider any sharp market selloff as an attractive opportunity to buy on dips, a strategy that has worked well for them so far.
Yet all is not well for the equity markets, and that reality has been a counterweight that has pulled back indexes. Yesterday’s spike in Ukrainian tensions serves as a reminder of geopolitical instability that, under a plausible set of conditions, could tip Europe and the global economy into recession. Valuations are also an issue, as is the Fed’s continued effectiveness in maintaining a sizable wedge between high equity prices and the more sluggish economic fundamentals underlying everything else.
Looking forward, an increasing number of professional investors are likely to gradually pivot away from targeting general equity market returns (the “beta” of the market) to one or more of three strategies: portfolios that are driven by more concentrated individual stock selection; reducing overall equity beta of portfolios by putting on general market hedges against specific long positions; and gradually accumulating higher cash balances to partially insulate their portfolios.
As this process continues, the equity markets may well lose some of the support that has proven so critical in blunting the scope and scale of price pullbacks in recent months. If this indeed occurs, investors may find out that they are underwriting a lot more price volatility than they currently realize.
Mohamed A. El-Erian is the former CEO and co-CIO of PIMCO. He is chief economic advisor to Allianz, chair of President Obama’s Global Development Council, and author of the NYT/WSJ bestseller “When Markets Collide.” Follow him on twitter,@elerianm.
Photo: JoePhilipson/Flickr, used under a Creative Commons license.
Principal at Reynolds Development, LLC
10 年You were the best guy at PImco!
Senior Financial Advisor , First Vice President- Investment officer at Wells Fargo Advisors
10 年Meredith P., there are a few flys in the ointment with regards to the US and Europe bankrupting Russia: We do not have the ability to deliver natural gas to Europe at this time. So what if prices are kept low. Try this scenario: Russia retaliates by shutting of supplies to Europe....unless they pay more. As of now what choice do they have??? By supporting Assad in Syria they have effectively prevented any gulf state from building a pipeline to Europe. The US is not exactly on firm ground economically and as we saw in 07-08 any major shock anywhere on the globe will be felt by all parties. Europe is a still train wreck. The media isn't paying any attention to the PIGS anymore because it's old news but things haven't improved very much if at all. France will NEVER be an economic factor as long as they continue down the road of ruin that is the ridiculous high tax entitlement state they are on. The UK may be improving but that's akin to a person coming of chemotherapy cancer free. Sure, the cancer is gone but their system is so devastated from the treatment that it is not realistic to call them healthy. Eastern Europe??? No That leaves Germany and Scandanavia A pipeline to deliver Russian oil and gas to China is in the works and they are now allowing oil transactions that aren't in US dollars Russia has been accumulating massive amounts of gold for some time. Last and most importantly both Russia and China own billions in US debt. There is evidence that the 07-08 liquidity crisis was exacerbated by both nations unloading US debt, an experiment of sorts. This is the proverbial "ace in the hole". China is NOT our ally and a coordinated dump of US debt would be catastrophic to the dollar. Putin is too calculating to have overlooked any scenario that could ruin Russia. Everything he has done this far has been carefully orchestrated. Has repeatedly made Obama look foolish and exposed how completely over his head and woefully inept he is. The ridiculous sanctions imposed and Kerry and Biden's impotent rhetoric has been laughed off by Putin for what it really is: saving face in the world of public opinion and nothing more We are at a huge disadvantage here.
Senior BI Consultant
10 年Worrying signs , fundamentals are not moving the market. Maybe this is a sign the market is topping off. I predict alternative energy to be a great play this year with all of the uncertainty of politics with Russia and global warming.
Software Development Contractor
10 年I'm not sure anything in particular was said here beyond markets will be jiggly. In comparison to certain other periods in human history, we are awfully lucky. I would be more worried about a property crash in China than Ukraine being overrun by Russia. The former involves a population ten times the size of the Ukraine. As the US drives down the price of oil and gas, oil propped despots around the world get desperate. The US and Europe will do to Russia what happened before, stress the country economically until it's bankrupt. Not that the Russians need any 'help' from outsiders.