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El-Erian: Time to Choose a ‘Better Place’ or Possible Recession

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The world has synchronized economic growth, says Allianz Chief Economic Advisor Mohamed El-Erian. “What has occurred is that there is more focus on pro-growth policies, and the U.S. is leading that,” he told an afternoon crowd Monday at the Inside ETFs conference in Hollywood, Florida.

“This is not the old type of growth from 15 or so years ago, which was finance driven, leveraged and [facilitated] by the central banks,” El-Erian explained. “This is much more general. Real things are happening.”

But what’s next? “If we stay here, we are not dealing with the underlying tensions,” the economist said.

At the T-junction, “We can turn to a better place with a [new] paradigm, the validation of asset prices and [where] there’s no need to talk about bubbles. Or, alternatively, we can take a wrong turn and end up with a much worse paradigm in which we have to worry about a recession,” he explained.

President Donald Trump’s policies are pro-growth, El-Erian says. But there’s still a need for greater focus on structural reforms, more done on infrastructure, education and labor reforms, and a more balanced fiscal and monetary stance, he adds.

In Europe, “There’s got to be change,” and that entails better fiscal and political integration, according to El-Erian.

Risks Ahead

“Geopolitics matter,” the economist told the crowd late Tuesday. “Markets cannot price this in gradually … and a shock means a market shift.”

He pointed to tensions in the Korean Peninsula, the Middle East and South China Sea as possible flash points.

“Other risks concern the economy. It comes down to the normalization of unconventional policies and if the Federal Reserve can continue to deliver normalization,” the economist said.

Globally, what will happen if central bankers in the U.S., Europe, China and Japan all try to normalize monetary policy at same time — meaning that they take steps like moving away from quantitative easing, raising interest rate and reducing the balance sheet? “One bank can do it orderly, but can four?” El-Erian asked.

Another risk is that there is a “market accident, not a policy mistake like what we saw in 2008,” he added. This might be related to “overpromised liquidity” tied to certain ETFs, for instance.

“I grew up with serious emerging-markets liquidity concerns or high yield [issues], meaning times when the underlying market could not provide you with endless liquidity,” the economist explained. “Now we have the overpromise of liquidity in some sectors. Do you get a contagion or not?”

While 2017 was a year in while many things that could have gone wrong did not create problems, this year could be different.

“There are lots of technicals in play and elevated valuations,” he said. “I expect this to be a bumpier ride with normalization of central bank [policies] … and more volatility.”

The central banks have been “giving us liquidity and nice policy guidance, but we have to start getting used to central banks not being our BFF — our best friend forever,” El-Erian said.

As we near this T-junction, he says, it’s good to “bet on secular and structural themes.” This means adding “a tactical layer on top of the structural and secular layers.”

“I am saying that we are coming out of one paradigm and into another, and that this is more probability of success than failure,” the economist said. “But not overwhelmingly so, so you must be tactical, too.”

— Check out Unusually Low Volatility Can Be Dangerous for Markets on ThinkAdvisor.


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