El-Erian: Will The Stock Markets' Tug of War Continue?
Equity markets are in the grips of a tug of war — between solid company fundamentals and macroeconomic uncertainty. This was again obvious last week as solid quarterly earning reports collided with unprecedented policy uncertainties in both the US and Europe.
This tug of war has resulted in roller coaster investment performance. Periods of impressive gains have alternated with unsettling losses. Fortunately, in net terms, the average investor remains in positive territory year to date.
Looking forward, neither dynamic is going away any time soon. Investors should therefore expect continued volatility. But this is not the major issue facing them today. Rather, it is whether the two dynamics will remain in broad balance over time, as they have so far this year; the alternative being one of the dynamics falling victim to the other, and resulting in a decisive market move.
The good news is that healthy companies, and there are many of them, will not lose their sound fundamentals any time soon. This is especially the case for multinationals where balance sheets are fortresses, profits are high, and costs are contained.
Unfortunately, this is not the only thing that will be with us for the foreseeable future. Macroeconomic uncertainties are also persistent. Indeed, if last week's developments are anything to go by, they could intensify.
In America, bickering politicians have taken the debt ceiling debate away from a grand bargain, which offered the hope of meaningful medium-term fiscal reforms, to somewhere between a disappointing mini-deal and an unsettling stop gap solution; and they could even end up in missing the August 2nd deadline. Should they fail to course correct, they will risk the valuable AAA standing of the United States.
Already, two rating agencies warned last week of the possibility of a downgrade in the next few weeks. And don't kid yourself, this is consequential stuff. America's AAA status is important for the stability and well functioning of both the domestic and the global economic and financial systems.
It is not surprising that such macro uncertainty is detrimental to consumer confidence and to animal spirits. As an example, witness Friday's dramatic fall in the Reuters/Michigan index of consumer confidence — to the lowest level since March 2009.
And then there is the worsening debt debacle in Europe. As I argued a week ago in a CNBC blog post, the contamination of Italy, if not countered quickly, is a potential game changer. Remember, this is the seventh largest economy in the world and the third biggest issuer of bonds.
In the run-up to yet another summit this coming Thursday, European policymakers are struggling to get ahead of their home grown crisis. Even last Friday evening's much anticipated release of the banks' stress test was a let-down.
To quote Philippe Bodereau, the talented leader of PIMCO's superb bank analysts, "the European PR machine has again outdone itself and managed to disappoint even rock bottom expectations."
The tug of war, between strong micro and weak macro, has persisted for months due to two major factors: continued sound corporate behavior, and the ability of American and European policymakers to convince markets that it is sufficient to simply kick the can down the road.
The former will continue; but the latter is now in play as both rating agencies and investors awaken to the reality that, rather than a can, it is a snowball being rolled down a hill - namely, problems get bigger by the day, and the underlying forces more difficult to control.
It is not too late for policymakers to step up to the plate. By doing so, they would allow strong company fundamentals to prevail and, with time, help improve the macroeconomic dynamics. The longer they dither and bicker, however, the greater the risk to markets and, more generally, national and global economic welfare.
Mohamed A. El-Erian is CEO and co-CIO of PIMCO, and author of "When Markets Collide"