PIMCO's El-Erian Believes the Rally Will Not Last

by: David Enke

There was a great interview with Mohamed El-Erian yesterday on CNBC. El-Erian always presents a well though-out, articulate, and accessible perspective on various financial issues. This interview was no different as he discussed the recent market rally and whether the economy is beginning to recover. As for the recent moves in the stock market, El-Erian believes that the run-up in prices, especially the July portion of the equity market rally, is part of a "sugar high," implying a correction is in order. As for the economy, El-Erian believes the current optimism is based on some false assumptions, including:

  • Corporate profitability can be maintained with additional cost-cutting. Not true. You need revenue growth.
  • The stimulus spending will have a permanent effect. Not true. Just look what happen in China on Wednesday when they decided to cut-back stimulus spending.
  • The stabilization of housing is sufficient to get the economy growing again. Not true. A housing recovery is necessary, but is not sufficient by itself.

El-Erian goes on to say that what we need is final demand, producing longer-term and sustainable demand sources. We also need to know that deleveraging in the private sector has completed its course. People need to feel comfortable to once again to engage in consumption and investment. Furthermore, the recovery is no longer just about the financial sector. It is about the real economy, in particular wages and employment. Until those recover, we can only have tepid growth, but not the level of growth necessary to turn the economy around. Finally, El-Erian mentions how the helium in the growth balloon is being driven mainly by public debt. For the balloon and growth to stay afloat, you need the private sector to kick-in and take over, as well as have the public sector begin dealing with its debt issues. Simple, to the point common sense. Good stuff as always.