Financial markets have been on a rollercoaster ride lately, and the elevated volatility is likely to persist, says Mohamed El-Erian, chief economic adviser to Allianz.
The S&P 500 index plunged 11 percent between Aug. 17 and Aug. 25. It then rebounded 6 percent through Aug. 28 and has slid 2 percent since then.
"The unusual volatility that has taken hold of financial markets in recent weeks, resulting in some impressive moves up in asset prices and many more harrowing declines, will be with us for a while," El-Erian writes in the Financial Times.
He identifies several factors that will keep volatility high. "First, the emerging world's spreading economic slowdown is eroding a fundamental underpinning of high and stable asset prices," El-Erian says. China reported growth of 7 percent for the second quarter, down from 7.3 percent for all of last year, and many economists say the true figure is 3 to 5 percent.
"Second, asset prices were high and, in some cases, in bubble territory," El-Erian writes. "China is perhaps the best example of this." The Shanghai Stock Index has dropped 39 percent since June 12.
In the United States, even after recent declines, Robert Shiller's cyclically-adjusted price-earnings ratio for the S&P 500 index, which accounts for 10 years of earnings, stands at 24.7. That's not far from its recent high, which trailed only the pre-crash periods of 1929, 2000 and 2007.
"It's a risky time," the Nobel laureate economist told CNBC.
"There's a risk of substantial declines. One shouldn't overreact, but the market is high now."
The CAPE ratio has averaged 16.6 since 1881, and a return to that level would put the S&P 500 at 1,300. That would represent a 34 percent drop from 1,957 Tuesday afternoon. The index hit a record high of 2,134.72 May 20 and touched a low of 1,867.01 Aug. 24.
To be sure, there have been sustained periods when the CAPE ratio stayed above historical norms, Shiller says. "Nobody can really forecast the market accurately. But I think this is a risky time." He said he has reduced his own stock weighting.
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