Submitted by Taps Coogan on the 11th of October 2018 to The Sounding Line.
Following yesterday’s sell-off in global markets, which included the third largest single day decline in the history of the Dow Jones, the question on everybody’s mind is: Is this the end of the road for the longest bull market in American history? Weighing in on that question is Allianz Chief Economy Advisor Mohamed El-Erian.
“The market is changing engines while flying at a high altitude… We were a liquidity driven market. We are becoming more (of) a fundamentally driven market. That’s good news over the long term. but we will inevitably have lots of turbulence in the short term…It’s not surprising that we are seeing this. The only question is why did it take so long…”
“I believe the US will be a 3% growth economy both this year and next year. The IMF has us at 2.9% and 2.5% but I also said… that they were too optimistic away from the US and that speaks to this key issue of divergence. When you get such divergent growth rates and policies, you start stretching markets. Remember, only yesterday the yield differential between the 10-Year Treasury and the 10-Year Bund was 2.7%. That’s enormous. So there is a lot of stress going on in the context of the US picking up momentum and the rest of the world decelerating…”
“You have to distinguish between the baseline and the risk scenarios. Yes, there are lots of risks. You could get a policy mistake by the Fed. You could get a market accident whereby the technicals take hold of this market, and yes we may end up in a trade war. I’ve put that probability at 25%… That’s a meaningful probability for such a big event. However, if you look at the baseline, there is something striking going on about the US. It’s not just about fiscal (stimulus). We are seeing a pickup in.. fiscal spending, but also household income and also business investment. So you have three domestic engines revving up at the same time and that should take us through this year and next. Thereafter, you need a hand-off from actual growth to potential growth. But for the next two years, growth prospects are good for the US.”
Asset prices, while highly elevated, are overlaying good economic fundamentals in the US. This presents a rare convergence of events: obvious asset bubbles, bearish global trends, and yet accelerating US economic growth.
We recently published an article ‘Out with BTFD, In with BTFR” in which we argued that the era of buying run-of-the-mill market dips may be over:
“The sum of global central bank balance sheets is expected to begin shrinking by the end of the year. As such, BTFD finally seems to ring hollow. Its raison d’etre, fungible central bank stimulus, is finally receding at a global level (for the first time in a decade).”
We also noted that, despite its many negative second order effects, QE programs succeeded in driving up risk assets and that if things get bad enough, at least some central banks will turn to QE once again.
“Whenever markets start to get really dicey again, the main thing that central banks will remember about QE is not the wealth divide or other ‘second order’ concerns but the fact that it succeeded in reflating asset bubbles. So while central banks are unlikely to reverse tightening for any run-of-the-mill market ‘dip,’ you can bet at least some of them will dust off the printing presses for a bone-afide market panic or recession. And while renewed stimulus will come with all sorts of concerning ‘second order’ effects, it will probably succeed again in driving up asset prices. Printing unlimited amounts of money and buying financial assets tends to do that. So while bad news may finally be bad news again, very bad news may very well be the best news of all for markets. Until very bad news arrives, the market is going to have to fend for itself for the first time in a decade. Out with BTFD and in with BTFR (Recession), aka ‘be cautious until things get really bad.'”
If yesterday’s market selloff leads to more selling, the question to ponder will be: how much pain will central banks allow the market to endure before signalling a willingness to accommodate, particularly in countries where growth has been slowing all year?
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