Pimco’s El-Erian: Stock Market Rally Is ‘Artificial’

Friday, 29 Mar 2013 10:38 AM

By Michael Kling

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The impressive stock market rally is “artificial,” being driven by central banks’ super-low interest rates, says Mohamed El-Erian, CEO and co-CIO of Pimco.

Going forward, the market will need more “genuine growth” in the form of strong corporate balance sheets and robust economic activity and less “assisted growth” from central banks, El-Erian writes in a blog for CNBC. That transition will probably occur in the United States, but not in Europe any time soon.

While the Dow Jones Industrial Average had its best first-quarter performance since 1987 and the Standard & Poor’s 500 surged 10 percent, “Investors,” he says, “need only look at where some other benchmarks ended the quarter to get a feel for the unprecedented and artificial nature of today’s capital markets.”

Editor's Note:
See the Disturbing Charts: 50% Unemployment, 90% Stock Market Crash, 100% Inflation

The stock market rally has coincided with continuing ultra-low bond yields, such as the 10-year Treasury down to 1.85 percent and a 10-year German government bond as low as 1.29 percent, and gold up to $1,596 an ounce.

Why that unusual combination of stock, bond and gold prices? Central banks, especially the Federal Reserve and European Central Bank, have fueled risk taking, driving up equities despite a slow economic recovery, a recurring eurozone crisis and ongoing worries about geopolitical risks.

In the coming weeks, he notes, we’ll get a better idea if the recovery is gaining speed and if central banks are willing to continue supporting asset prices. El-Erian predicts they’ll say they are willing to continue supporting economic and job growth.

“Indeed, the willingness call is a relatively easy one,” he explains. “The much more difficult call relates to the sustained ability of central banks to maintain control over the range of competing and conflicting forces.”

Investors have no historical precedents or reliable models they can use to predict the future, he points out.

The scope and scale of central bank operations are already unprecedented. Once unthinkable capital controls were imposed on a eurozone country, and analysts continue to worry about geopolitical risks, he writes, referring to Afghanistan, North Korea, Pakistan and Syria.

While central bank interventions are sometimes needed, he maintains, “Actions need to be strong enough to offset Congressional dysfunction and headwinds from abroad. But if too strong, they would damage for a long time the functioning and integrity of markets.”

Other commentators have also called the latest stock market artificial and due mainly to the Fed pushing rates down. But Fed Chairman Ben Bernanke says the Fed’s low-rate policy is not creating a stock bubble.

“In the stock market, we don’t see anything that’s out of line with historical patterns,” Bernanke says, according to The Washington Times.

Stocks, he notes, are below all-time record valuations after adjusted for inflation.

Editor's Note: See the Disturbing Charts: 50% Unemployment, 90% Stock Market Crash, 100% Inflation

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