PIMCO’s El-Erian: Focus on Absolute Levels of Economic and Market Data

I am increasingly impressed by Pimco CEO Mohamed El-Erian. Why? I believe El-Erian consistently provides a thoughtful and informed opinion and analysis of the global economic landscape. I witnessed his sagacity again Tuesday in his Financial Times commentary.

We are at the point of maximum confusion in the multi-year transition of the global economy, markets and policymaking. We have left the global growth regime that was driven primarily by debt-financed consumption in the US, but we have not as yet reached a position of more balanced, albeit anaemic, growth. Those who lack a robust anchoring framework, be they investors or policymakers, risk being misled and backtracking to outdated ways of thinking.

I concur with El-Erian’s premise. As much as consumers, investors, bankers, and politicians may want to return to ‘business as usual,’ the fact is the global economy and the markets are a dramatically changed place. While market analysts and government policy wonks feed us a steady diet of ‘green shoots’ and ‘positive change in the rate of change,’ El-Erian properly frames the debate by focusing on the absolute levels expressed in economic and market data rather than merely the rate of change in those levels.

I made a less eloquent attempt at stating this premise this past July 29:

While most economists and market analysts are looking at statistics and data to determine whether the economy and consumers are improving or rolling over, my take is different. I view the economy and consumers as adapting to the new dynamic at work in our country.

While those on Wall Street and their friends in the media would revel in short term developments and daily market swings, I view our market and global economy as akin to running a marathon. As such, I would place us at best at the 7-mile mark. El-Erian makes a similar assessment and states as much in writing:

Today’s lack of appropriate anchoring frameworks appears to be exacerbating short-termism. The issue goes well beyond the still-limited appreciation of the multi-year realignment of the global economy, which is gaining momentum. It also relates to tendencies well-documented by behavioural economists – such as framing the problem wrongly and refusing to question past approaches.

Given all this, we would be all well advised to follow the admonition of Mervyn King. Last month, the governor of the Bank of England stated bluntly: “It’s the level, stupid – it’s not the growth rates, it’s the levels that matter here.” Investors have not yet accepted his insight that the absolute levels of income, debt, wealth and unemployment, not just the rates of change, are what matters today. They need to, and soon.

What ‘heart rate monitors’ does El-Erian utilize to assess the overall health of our global economy? He offers the following:

First, consumer indebtedness is still too high relative to income expectations and credit availability, particularly in the US and the UK.

Second, some banks’ balance sheets are still too geared for the comfort of regulators or their own managers. This will inhibit them from lending to the real economy at a time when certain sectors (such as commercial real estate, but also residential housing) still require significant refinancing, and when consumers need time to work down their excessive debt loads.Third, unemployment has risen well beyond expectations, and is likely to prove unusually protracted.

Finally, public debt has grown so rapidly as to spark concerns about future debt dynamics. This would inhibit the effectiveness of future stimulus measures, as well as complicating the formulation of exit strategies.

I encourage readers to take Mr. El-Erian’s assessment to focus on the absolute levels of economic and market data. In the process, please then incorporate that approach into the report on deflation I offered yesterday.

I commend Mohammed El-Erian for properly framing the debate. He is helping us all see the ‘forest for the trees’ as we navigate the economic landscape.

Comments

[conceptwizard:]

Over the past several weeks I have noted that the Baltic Dry Freight Index, which has led commodities and stocks, topped in June and has been declining sharply. The past week, commodities have declined sharply, producing a very ugly technical picture. It appears that commodities and stocks will now reconnect to some degree with the real economy as reflected by the Baltic Dry Freight Index.

Sep 29 06:09 PM

[herbert hoover:]

I wouldn't believe anything anyone at PIMPCO has to say.

Sep 29 07:38 PM

[Denis Gould:]

El-Erian's book When Markets Collide is the best investment book I have read in a long time and I believe he is honest in his commentary. However as herbert hoover says it is sometimes difficult to believe THE bond manager isn't just talking the story that suits their book. Bill Gross was also out on the tapes yesterday talking the bull case for Treasuries.

However his comment that confusion over a regime shift is fuelling short-termism is spot on. Try to talk even to investment professionals about taking a view on a 5 year horizon and they will look at you as if you have green skin and antennae.

Sep 29 08:40 PM

[Old Trader:]

"El-Erian's book When Markets Collide is the best investment book I have read in a long time and I believe he is honest in his commentary."

Agreed. I read it earlier this year, and he seems to be pretty much spot on, at least as things have been unfolding, so far.

Sep 30 10:39 AM

[BRUCE E. W.:]

Well I do know that Greenspan also apparently works with PIMCO and that PIMCO bonds did quite well throughout the worst of the crisis transition so far. It is difficult to believe that any information isn't loaded for a self serving purpose rather than public sector revival for its own right. Everything must be measured with a careful eye. I do like the basic excerpt you presented and hopefully this is not just a bated hook by Mr. El-Erion & Co.

I am actually more delighted with your own (modestly presented) insights and I agree with the grounded approach you see as essential to a total package of restoration. A restorative process through adapting realistically as a full spectrum economy (and not just a system of revenue measuring fiancial services promising wealth on a debt ridden diet) seems to be missing from the theory bound postures of corrective measures. Brand name theory instead of ground floor inventories simply are going to grow another top heavy implosion on us all. What business would think that taking loans and exchanging paper shares of invisable assetts is a substitue for actual economic sustanence? Thanks you for bringing real practical wisdom back into the game. I was beginning to wonder if we would be soon eating all that paper wealth for they are producing as "recovery" in all those forward looking projections from Big Finance and leveraged Titanic owners. Bon Appetite!

Sep 30 01:18 PM

[Larry Doyle:]

Bruce,

Thanks for your kind remarks. I appreciate them.


On Sep 30 01:18 PM BRUCE E. W. wrote:

> Well I do know that Greenspan also apparently works with PIMCO and
> that PIMCO bonds did quite well throughout the worst of the crisis
> transition so far. It is difficult to believe that any information
> isn't loaded for a self serving purpose rather than public sector
> revival for its own right. Everything must be measured with a careful
> eye. I do like the basic excerpt you presented and hopefully this
> is not just a bated hook by Mr. El-Erion & Co.
>
> I am actually more delighted with your own (modestly presented) insights
> and I agree with the grounded approach you see as essential to a
> total package of restoration. A restorative process through adapting
> realistically as a full spectrum economy (and not just a system of
> revenue measuring fiancial services promising wealth on a debt ridden
> diet) seems to be missing from the theory bound postures of corrective
> measures. Brand name theory instead of ground floor inventories
> simply are going to grow another top heavy implosion on us all.
> What business would think that taking loans and exchanging paper
> shares of invisable assetts is a substitue for actual economic sustanence?
> Thanks you for bringing real practical wisdom back into the game.
> I was beginning to wonder if we would be soon eating all that paper
> wealth for they are producing as "recovery" in all those forward
> looking projections from Big Finance and leveraged Titanic owners.
> Bon Appetite!

Sep 30 06:18 PM

[Analyste de...:]

I don't know what role he played, or how significant his allocation insight was, but the Harvard Endowment just months after Mohamed El-Erian bailed fared poorly indeed.

There's a 'rest of the story' missing here - what investment calls was El-Erian making at HMC in 2005 & 2006 that set up Harvard for the fall?

Nothing like time to erase the memory: www.investmentmoats.co.../

Oct 14 03:37 PM

[Larry Doyle:]

El-Erian was not at Harvard long enough to truly make a difference.


On Oct 14 03:37 PM Analyste de Boston wrote:

> I don't know what role he played, or how significant his allocation
> insight was, but the Harvard Endowment just months after Mohamed
> El-Erian bailed fared poorly indeed.
>
> There's a 'rest of the story' missing here - what investment calls
> was El-Erian making at HMC in 2005 & 2006 that set up Harvard
> for the fall?
>
> Nothing like time to erase the memory: www.investmentmoats.co.../

Oct 14 04:25 PM

[Analyste de...:]

I doubt that's true, and the blame lies somewhere between Larry Summers and El-Erian. I suspect it more Summer's fault.

The rest of the story's emerging at Bloomberg:
www.bloomberg.com/apps...


On Oct 14 04:25 PM Larry Doyle wrote:

> El-Erian was not at Harvard long enough to truly make a difference.

Oct 18 04:51 PM

[Analyste de...:]

"There's nothing here folks! Keep moving right along!" Really?

El-Erian managed HMC from February 2006 until July 2008. He was brought in by Summers, right? There's more to this story, developing...

Excerpt: tinyurl.com/ykpxwbv
The minutes of the Harvard board meeting where Summers heard newly hired endowment chief Mohamed El-Erian pitch the derivatives should make interesting reading for Harvard alumni, as the school expects them to come to the rescue for this investment debacle, the worst single loss in Harvard’s long history. {...}

One big question is why Harvard would even elect to go into this derivative transaction as the counterparty payer. The deal El-Erian
sold to Harvard was bereft of any 'escape hatches,' any stoploss
limitations if the LIBOR rate plunged. Another question is why
Harvard even had to get so much credit 'insurance' for building loans not yet made. At most, if Harvard did not want to self finance the construction, the school needed $250 million in derivatives.

The answer may lie with Pimco, if that company bought up Harvard
counterparty receiver derivatives from the financial firms that
originally held the Harvard paper. After Harvard fired Mohamed El-
Erian, Pimco hired him as their CEO. Whoever held these Harvard
derivatives as receiver made a billion dollar profit when Harvard paid to bail out of its foray into the derivative death zone."

This isn't to exonerate Summers - the culpability is debatable:
thisnewenglandblog.pro...

Oct 19 01:41 PM