PIMCO's Cyclical Outlook:Aftershocks of Financial Dislocation

In its latest Cyclical Outlook,composed at an investment forum by its international cadre of financial experts,PIMCO portrayed a world that is still very much feeling,and being influenced by,the shock waves from the global financial crisis.
Notwithstanding the recent calmer tone in the markets,wrote PIMCO's Joachim Fels,Global Economic Advisor,and Andrew Balls,CIO Global Fixed Income,in a PIMCO Insight,the weaker global growth economic momentum at the end of 2015/start of 2016 and the significant,though temporary,tightening in global financial conditions in January/February meant that 2016 economic growth and inflation would likely come in at or below the ranges they had forecast in December for most major economies.*
Consequently,the investment forum lowered PIMCO's forecast for calendar year 2016 global real GDP growth by a quarter-point,to a range of 2-2.5%.Actual global GDP growth was 2.8 in 2014 and 2.6 last year;their forecast sees the slowdown continuing.*
Wherever one looks around the globe,PIMCO believes,nominal and real GDP growth and,therefore,interest rates are likely to stay well below historical norms,very much in line with their New Normal concept of a world economy transformed after the global financial crisis of 2008.The New Normal,Fels and Balls explain,is characterised by both weak potential output and a lack of aggregate demand,reflecting high debt levels and an excess of global desired saving over investment-the global savings glut.This continues to provide significant headwinds for growth,not only on their secular 3-5 year horizon;but also over the cyclical 6-12 month timeframe.It underpins their expectations for a low "neutral" central bank policy-along with The New Normal,they have described The New Neutral,referring more explicitly to central bank policies converging to lower neutral rates than in past economic cycles.*
PIMCO puts the probability of a US/global recession over the next 6-12 months as at most 20%.This is because,right now,none of the typical signs of imminent collapse are flashing:no over-consumption;no over-investment;no over-heating;and no monetary overkill.In short,they expect this expansion to last,lackluster though it be.

Economic Advisor:Where We Are and What You Can Do

The key issue is that the road we are on right now is going to end,predicted Mohamed El-Erian,chief economic advisor at Allianz.Central banks will no longer be able to borrow against the future;we're getting less growth out of the system;the political regimes are getting more extreme.That has massive implications on how you're going to position yourself at this T-junction.The Fed doesn't want to be forced by the market into a change of policy stance.The market welcomed the rate hike;now its view is shifting.
We never achieved liftoff.We never got to what this economy is capable of,and that's a tragedy.*
This year,it's hard to get a recession.I think the probability of a recession goes up to about 30% for 2017,and then we get to the T-junction where major decisions have to be made.We have financial prices separated from the fundamentals.We can't let the currency markets carry all the burden.*
I think this year will be a great year for those who can pick the right stocks,and there's going to be lots of opportunity.I still think you need cash;you need 25-30% cash right now,advised Dr.El-Erian,who holds degrees from both Oxford and Cambridge Universities.His new book is "The Only Game in Town:Central Banks,Instability and Avoiding the Next Collapse."

Will the Fed Raise Rates This Month?

I think the volatility is going to sideline the Fed in September,said Mohamed El-Erian,Chief Economic Advisor at Allianz.The second and the third facts have turned violently against the Fed.If they make a mistake,it could spill over into the economy.There isn't much the Fed can do.The market doesn't have the circuit-breakers that it needs.That is a major paradigm change for the marketplace.The market has to find its own equilibrium and level,and that's going to take some time.*
China helped create a market bubble in their stock market,and now they're finding it very hard to control.I think they will be able to soft-land the economy at around 6%,but we are going to observe the financial instability.
I pay a lot of attention to the currency markets.It started flashing red early on and started contaminating other markets.Central banks are having tremendous difficulty because the currency markets are coming unhooked regardless of what the fundamentals are,and the fundamentals are stronger relative to the rest of the world,noted Mr.El-Erian,who is a native of Cairo,Egypt.

Federal Reserve Modifies Guidance,Not Policy

Although the Federal Reserve's Open Market Committee held steady its low interest rate monetary policy on Wednesday,it has altered its guidance because it doesn't want to be bogged down in the past.The FOMC reaffirmed that the 0-0.25 interest rate range remains appropriate,Fed Chair Janet Yellen said in a news conference after the FOMC meeting drew to a close-the last such meeting of the year.The FOMC judges it can be patient in beginning to normalise monetary policy,Ms.Yellen continued;adding,however,that some modification to our guidance is appropriate at this time.The majority of the FOMC believes interest rates will be raised in 2015.*
Progress continues to maximum employment.Job growth has been strong recently.The Committee continues to see sufficient underlying strength in the economy to continue to support employment growth.Inflation continues to run beneath the Committee's 2% objective.The Committee expects inflation to gradually move back to its objective.For the US,the oil price drop is a net positive.*
History shows central bank independence promotes better economic performance.We are accountable to Congress in explaining what we do,but I would be very concerned about any change to the policy of no audits of monetary policy.*
We certainly did review global economic developments,including developments in the Russian economy.The drop in oil prices is posing a series of difficult conditions for the Russian economy.I expect the spillover to the US would be small,Ms.Yellen noted,citing the small percentage of Russian holdings in US portfolios and the small amount of trade between the two countries.*
The S&P 500 rose 40.15,or 2,4%,in response to the Fed's decision.

Where The Financial Problem Is-and how to deal with it

The problem is,central banks don't have the right tools,according to Mohamed El-Erian,CEO of PIMCO.The best they can do is provide a bridge,but it has to be a bridge to somewhere.
The politicians aren't doing enough.People are refusing to invest because of the uncertainty.The Fed has been the investor's best friend,supporting valuations and markets.
Our baseline is 1.5% growth-plus or minus 0.5%.If politicians don't get their act together,that would push us into recession.If nothing happens,that will unambiguously throw us into recession.
The sooner,the better.Already businesses are pulling back,investing less.
Be very careful.Focus on sovereigns and companies with strong balance sheets and can give back cash to shareholders,Mr.El-Erian counseled.
Mohamed El-Erian is also co-Chief Investment Officer at PIMCO along with founder Bill Gross.The company now offers a wide range of both active and passive exchange-traded funds,as well as mutual funds.

MIT Professor:Finance and Politics

The riskiness of the market isn't nearly as predictable as it used to be,points out Andrew Lo,Professor of Finance at the MIT Sloan School of Management.Factors are pushing the markets.The entire sector is getting hit,not individual companies.
The Americans and Europeans must fix political problems.Fiscal integration in Europe is really inevitable.All of this debt on banks' balance sheets must be dealt with.There must be write-downs,recapitalisation and ultimately privatisation.We're waiting on the edge of our seats for these politicians to get their acts together.
We have to understand the global linkages across all these platforms.Any kind of coordinated activity means that things are really bad.Central banks have relatively few tools.Ultimately it's the political process that has to create the atmosphere for resolution.
We've been dealing with a lot of structural issues.Spending in the short run will help,but it is unsustainable.Ultimately,the only way to do it is cold turkey.Investors are scared.We're staring into the abyss.There are a lot of people in cash.They need to be able to invest in risk assets for their retirement.We need to restore trust in the financial system,Professor Lo reflected.
Dr.Lo has a PhD in Economics from Harvard University.He is an authority on hedge funds and financial engineering.His books include "Dynamics of the Hedge Fund Industry" and "Market Efficiency:Stock Market Behaviour in Theory and Practice."