The Dow barely moved on Thursday, as traders, some with unaccustomed losses for the year, sought to build a successful quarter and wondered whether the Fed would raise interest rates by a token 25 basis points at the next FOMC meeting scheduled for October 27-28, whether the price of oil could gain upward momentum, and whether the dollar would strengthen and act as a headwind for earnings growth.
Earnings forecasts have a pessimistic tone, but cynics suspect this is to set a low bar so that results can be cast as having exceeded expectations.
Against this background, Mohamed El-Erian, of Allianz, appeared on CNBC
's "Fast Money’s Halftime Report" to talk with Scott Wapner about the state of markets.
El-Erian began by comparing the current circumstance to 2008, when “People didn’t trust each other; they weren’t willing to take simple counterparty risk.” This writer’s thought has been that TBTF bankers knew they were in bad shape, suspected that the other TBTFs were as bad off, and didn’t want to deal with banks in the same condition as their own.
This later morphed into the Kabuki play in which the bankers protested that the government was throwing money at them that they didn’t need and didn’t want, as officials insisted they were bailing out only “healthy” banks.
Now these officials are saying banks have much more capital than in 2008, but as a witness before the Senate Banking Committee quipped, “Twice very little capital is still very little capital.”
El-Erian agrees with Carl Icahn that this is not the case today and that the financial system is not in danger of freezing up. His complaint today is, “We’re not getting the hand-off from liquidity-boosted asset prices to better fundamentals; it’s not happening.” Implicit in this statement is that markets aren’t benefiting as much as expected from the Fed’s QE and ZIRP policies.
Therefore, he concludes, “There is a big wedge that needs to be resolved, between high valuations and sluggish fundamentals.” He sees two ways in which this wedge can be resolved: “the good way, with fundamentals validating the asset prices, or the bad way that (Icahn) is worried about, which is a major shakeup in the financial markets.”
El-Erian agrees with Icahn that, “The balance is starting to tilt, because the policy makers are not responding.”
Wapner asked whether the period ahead will be like 2011, where there was pain, but the market recovered to deliver “the kind of gains it historically has.” El-Erian agreed, with the caveat that whereas 2011 was “about problems in the US and in Europe,” with central banks that were “incredibly powerful, committed, and credible,” today the locus of the problem is emerging markets, all of which are slowing down, with Russia and Brazil already in recession, while, “The ECB and the Fed cannot reach over there.
That’s the problem, right? So the difference today is that the source of risk is not within the direct purview of the central banks we trust in. I think that is a fundamental difference.”
When Wapner asked whether this is enough to cause a recession in the US, El-Erian said no, but “it’s enough to cause a recession in Europe, and emerging markets that were the locomotive of growth have now become the caboose, and the US is sound but not powerful enough to pull everybody up.”
This writer disagrees with El-Erian that the Fed can be trusted and agrees with Peter Schiff that assets are overvalued, and ultimately the Fed will intervene with another round of QE in order to avoid the “writedowns and fire sales” of which the IMF’s Christine Lagarde warns.
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