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.