Tags: El-Erian | front | yield | curve

El-Erian: 'Fasten Your Seat Belt' but Stay Calm

By Dan Weil   |   Tuesday, 03 Dec 2013 07:20 PM

Investors should consider short-term bonds as the Federal Reserve readies a tapering of its quantitative easing (QE) and shifts to forward guidance, emphasizing continued low short-term interest rates, Pimco CEO Mohamed El-Erian told CNBC.

QE has boosted the stock market, El-Erian said. But now, "lower a little bit the QE trade, because the QE trade is getting pretty old, especially when the Fed is looking to pivot away from QE and toward forward policy guidance."

The Fed will keep short-term interest rates low, El-Erian said. "They're going to do that by
keeping the policy rate [federal funds target] at zero [to 0.25 percent] probably well into 2016 and by getting more aggressive on forward policy guidance," he predicted.

Editor’s Note: 5 Reasons Stocks Will Collapse . . .

But, "it's doubtful whether they can anchor the long end of the curve. Absolutely, this is a Fed committed to low rates, but let's not overstate how much control they have over the yield curve."

And how should investors react to the central bank's policy?

"In fixed income, focus on the front end of curves," El-Erian said. "They are safer. There's still value there, given that the Fed isn't going anywhere for a while."

In stocks, it's no longer a risk-on trade, El-Erian said. "Look at sectors. This is going to be a very sector-specific market. Look at the disparities that have occurred across the world — that some emerging markets now are looking attractive relative to the U.S," he added.

"And finally, fasten your seat belt. There's volatility ahead as the Fed tries to change its policy mix."

With investors starting to put money into stocks as they pull it out of bonds, there is talk that the "great rotation" to stocks from bonds has begun.

In El-Erian's view, "there's a small rotation and a big rotation." "The small rotation is
from fixed income into equities," he said. "The big rotation is within fixed income. People within fixed income are reducing duration risk and increasing credit risk and increasing absolute return risk."

El-Erian stressed that he's not urging investors to dump all their stocks. "I would say lower a little bit the U.S. exposure and start taking exposure elsewhere, all within the context of lowering the equity beta [volatility]," he said.

"On fixed income, focus on the alpha [return] opportunities located in the curve. And then, if you are a credit investor, look for companies that offer strong balance sheets and exposure to growth."

It's no longer a classic choice between asset classes, El-Erian said. "These are going to be much more differentiated markets, both in fixed income and in equities."

Meanwhile, El-Erian's Pimco colleague Bill Gross, co-chief investment officer, warned about the dangers of global central bank easing in his monthly market commentary.

"Investors are all playing the same dangerous game that depends on a near perpetual policy of cheap financing and artificially low interest rates in a desperate gamble to promote growth," Gross wrote.

Accommodative central banks "are basically telling investors that they have no alternative than to invest in riskier assets or to lever high-quality assets," he said.

Editor’s Note: 5 Reasons Stocks Will Collapse . . .

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