Mohamed El-Erian Hoists Hurricane Flag on Risk

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Mohamed El-Erian, co-CEO of Pimco, usually strikes a cool, rational tone in his periodic comment pieces in the Financial Times.

Today’s article, “Traversing wild market swings,” is a noteworthy departure. Or maybe it isn’t. El-Erian keeps to his detached, analytical style,but the guts of his message is so blunt that the packaging is secondary:

Successful risk management must reflect the fact that markets are now in the grip of three distinct but reinforcing forces that will play out over a number of quarters.

First, look for further balance sheet contractions in the financial sector that will continue to suck oxygen out of, and undermine risk appetite in credit and equity markets. This is part of a long-term process of de-risking that is currently driven by markets but will soon have a more important regulatory dimension.

Second, markets are yet to adequately price the morphing of the credit crunch into a full-scale US economic disruption. Prepare for even stronger headwinds fuelled by declining real income and eroding household wealth.

Third, there are no easy policy solutions. Instead, policy makers face an extremely difficult situation in which any action, no matter how well-intentioned, entails unstable feedback loops and impose distortions elsewhere. Collateral damage cannot be avoided, yet its exact characterisation is uncertain given the extent of still-hidden vulnerabilities in both the real economy and the financial sector.


Now El-Erian continues with what amounts to a “in times of great disruption, there is great opportunity,” speech. Misvaluations will abound. But reading between the lines, the picking will go to the big fry. Ah, why is it just about inevitable that the rich get richer?

He warns that anyone who goes into the deep end of the pool now needs to have more than adequate reserves, a cast iron stomach (volatility will be high), high tolerance for intermediate losses, and a willingness to consider all sorts of cats and dogs (“a process that accommodates opportunities that, in some cases, do not fit well into traditional classifications of asset classes”).

For the rest:

….you are well advised to stay on the sidelines, focused on the probability that these same markets will also be treacherous for at least the remainder of this year.

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  1. Anonymous

    Which, to me, implies that the SWF’s of oil rich states and China are going to make a killing in the long run as they are the ones running the oversized capital surpluses right now.

  2. S

    In the long run we are all dead. Didn;t I read somewhere the other day that buy and hold is dead. Sad plea not to abandon the markets..enough already

  3. Anonymous

    To answer the (rhetorical) question you posed Yves,”Why is it that the rich get richer” takes us to “tinfoil hat” land but a conspiracy doesn’t have to be present for a group of individuals to always win.

    Its obvious to anyone with half a brain that the only people benefitting from the current environment are those with lots of capital. Either because they can protect it better by moving it to the best preservation instrument available or their standard of living is not affected one bit by a 40-50% drop in real value (Oh gosh, my 200 billion dollar portfolio is only worth 140 billion now!)

    When real estate settles out, the vultures will fly in buy it cheaply and then rent it back to US at a nice little profit. How decent of them.

    This wasn’t “orchestrated” per se, but it is HOW the system works (presently) and the rule makers know best how to navigate it.

    BTW, this has become my favorite site.

    Thanks for what you do Yves.


  4. Francois

    “Ah, why is it just about inevitable that the rich get richer?”

    I agree…and disagree. It is not “inevitable”‘ rather, it is highly more probable (and easy to do) that the rich will get richer.

    Some people with modest means may become quite wealthy. They’ll hunker down on consumption, keep on working and saving the maximum possible while scanning around for opportunities, all systems fully activated, then pounce when ready.

    Won’t be easy to pull off, but some will do it.

  5. James

    I wouldnt make too many predictions about what can happen. Its possible things go really wrong for everyone.

  6. Anonymous

    Ah, why is it just about inevitable that the rich get richer?

    Not sure it will play out that way. The last great disruption aka the Great Depression wasn’t kind to the rich. They overplayed their hand then and got socked.

    It may be the same now and the real opportunity may well be for governments to reassert themselves. Anyway, they will have to jump in and put the financial system back in shape.

  7. ajw

    Anonymous @ 1:53 hit the nail on the head – let’s not forget that El-Erian is also about to launch a new mutual fund with a specific mandate to capitalize on the very things he discusses in his commentary. Not to detract from the truth of his research, but it does pay to bear in mind that his agenda is not entirely disinterested.

  8. Anonymous

    Sy Krass said…

    Anon 3:38 has it right, deflation and depression occurs when too much wealth is concentrated at the top. Too many people have not enough money to keep prices and assets up by purchasing services, thus “deflating” everything, even for the rich. The “system” desires equilibrium.

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