Forget bubbles—what about air pockets?
Mohamed El-Erian notes that some argue the recent lackluster performance of global stocks is evidence that markets are "tenuously positioned" on an air pocket.
The PIMCO CEO, who runs the world’s largest bond shop, would put it differently. Writing a guest blog on CNBC’s website on Friday, he says, “While markets have deviated quite a bit from economic fundamentals, this is due to central bank activism.
“Over the last few months, central bankers have reinflated the wedge that separates weak fundamentals from high market prices,” El-Erian says. “Whether it is the Fed's open-ended QE3 and extended forward interest rate guidance, or the European Central Bank's unlimited securities purchase program, robust asset markets are an integral part of policy attempts to counter tail risks and deliver economic growth and jobs.”
By artificially inflating asset prices above levels justified by sluggish fundamentals, he adds, these two central banks hope to “calm market concerns, ignite animal spirits and trigger the wealth effect. And their actions are contagious.
“Whether they like it or not—and many don't-other central banks continue to be pulled into more accommodating monetary policy. Witness this week's round of interest rate cuts in Brazil and Korea as an example.”
These cuts did not happen because they constitute a “first best policy,” he writes. Rather, they seek to counter the collateral damage emanating from the unconventional policies pursued by Western central banks.
“There is a limit to how far and how long prices can deviate from fundamentals. This is particularly the case when central banks, acting without the support of other government entities, do not have sufficiently-refined tools to secure good and sustainable economic outcomes.”
Concluding that “investors' romance with the ‘central bank put’ should not be unconditional or everlasting,” he notes. “Central banks should be respected. And they can certainly counter air pockets, but not forever.”