Stocks will be the last asset class to recover from the financial crisis, and investors should focus on high-quality investments in the interim, Pimco CEO Mohamed El-Erian told CNBC.
In addition, while it's tempting for investors to try to call an end to the crisis, El-Erian said they should focus instead on being positioned for the next phase of the financial turmoil.
"This is not a crisis in the system, it's a crisis of the system. We are morphing now from a deleveraging phase, which we're about three-quarters through, to a phase of economic weakness. The next stage will be policy response. Investors have to make sure they stay ahead of the morphing," says El-Erian.
As for policy response, El-Erian says the market wants action yesterday and see it be effective.
But, policy makers have a different schedule and can only deliver in a few months time. So there's a clash of worlds, he said.
According to the Pimco CEO, the first step in the recovery process is "unclogging the pipes of the system, healing the money market, healing the commercial paper market, and getting people to lend. That will happen over the next few months."
After that, says, El-Erian, "We'll see a slow sequential healing. This isn't the time to buy risk assets indiscriminately."
"The first priority is to stop the vicious cycle of deleveraging that feeds on itself and is indiscriminate in nature."
El-Erian says the hedge fund sector has already calmed down a bit "because a number of hedge funds have put up gates that make it longer for them to sell."
But, he says, the reality is that the sell-side is being de-risked.
"Look for a shake-out and consolidation in the sector. The best will survive, but quite a few won't."
In October alone, hedge fund assets lost as much as $100 billion in value. Experts estimate that hedge funds probably have a total $1.6 trillion under management, down from a peak last year of about $2 trillion at the height of the hedge fund boom.
On Nov. 13, five leading hedge fund managers will testify before the House Committee on Oversight and Government Reform. They include George Soros, John Paulson, Philip Falcone, James Simons, and Kenneth Griffin.
"In an attempt to respond to public outcry and political demand, the industry expects lawmakers to implement new rules that will limit leverage, restrict the ability to short securities, and increase taxes on the wealthy," Ron Geffner, a lawyer at Sadis & Goldberg, which represents hedge funds, told Bloomberg.
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