Mohamed El-Erian, the chief economic advisor for Allianz, says we have borrowed market returns from the future. Respectfully, I disagree.
During his keynote address at the IMN Global Indexing conference this week, El-Erian said the world has seen economic, financial, political and geopolitical instability, but attractive financial returns.
This is the same brilliant economist who coined the famous term "the new normal" after the 2008-2009 stock market plunge, predicting lower investment returns going forward. But being brilliant doesn't mean you're clairvoyant. The reality is that both stocks and bonds have had high returns, and if you had followed his advice, you would have missed out on much of the great bull market.
Let's examine his latest keynote address that I heard at the IMN conference in Scottsdale, Ariz.
He said these attractive returns are due to global central banks flooding markets with liquidity pointing to negative nominal rates in Europe. The fundamental issue, however, is that we have failed to restore economic growth. We are no longer worried about inflation and are now talking about deflation. He stated that we have "borrowed returns from the future."
This is where we disagree. I call this the "markets are stupid" theory and perhaps an excuse for why his past prediction of low returns was dead wrong.
PREDICTING MORE VOLATILITY
El-Erian said 2016 will bring more divergence in world economies and central bank policies with the U.S. raising rates while other countries, such as those in the European Union, keep rates low with more quantitative easing. In the year ahead, this divergence will result in more volatility leading to patches of illiquidity, leading to even more volatility and more surprises in covariances (unpredictability of relative asset class performance).
Beyond 2016, El-Erian says the central banks must change policy as continued worldwide quantitative easing and zero short-term rates can't continue to carry the market. We will take one of two paths. Politicians may get their acts together to grow economies and restore the fundamentals to support current market prices. If not, monetary policy will fail and asset prices will plunge. He sees roughly a 50% probability of each path.
If the path is negative, he predicts even more volatility, with some markets becoming unhinged. He pointed to oil markets today as being unhinged. El-Erian argued to keep portfolios flexible to see which path we take. Keep an allocation to cash, he advised.
'THE OLD NORMAL'
If you had followed the "old normal" of rebalancing (buying more stocks) after the market plunge, you would have fared much better. El-Erian gives too much credit to central banks, not mentioning that interest rates actually declined sharply in 2014 after the Fed ended quantitative easing. Economists uniformly got that prediction wrong.
I asked El-Erian about that and he explained that markets got stock returns right, pointing to short-term market volatility impacting the Fed's decisions on rates. I found that completely contracting his statement that we borrowed returns from the future.
I agree with El-Erian that the world is a more dangerous place and that politicians worldwide need to get their acts together. Central bank monetary policy certainly is diverging. I just don't see that this translates to investing or knowing future returns. I see the markets making fools of those believing they are brilliant and markets are dumb. Accepting uncertainty feels bad and feeling bad is typically a good sign in investing.
We have not borrowed returns from the future and no one actually knows the future. My only prediction is that investing based on new paradigms will continue to fail.
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