Mohemed El Erian believes that economists and markets are underestimating the economic impacts of the Great Shutdown. The restart process will be inherently messy.
He highlights growing evidence: trends of larger companies suspending earnings guidance with profits deteriorating; an avalanche of credit ratings downgrades; a rush to raise precautionary cash through debt issuances (supported by central bank market interventions far exceeding those of the 2008 global financial crisis); large-scale layoffs in the space of three weeks equivalent to the highest unemployment rates during the globally financial crisis.
Emerging risks include challenging earnings outlooks; higher levels of indebtedness; larger dispersion between winners and losers; growing entanglement of government in private sector activities; potentially long lasting risk aversion in the real economy not seen since the Great Depression (including frugal consumer behaviour); and most importantly a huge number of bankruptcies.
The market misunderstands: fiscal and monetary policies announced to date can assist with short term liquidity and market stresses, but they can neither avert corporate and developing country defaults nor restart the economy quickly.
Investors should take this opportunity to prepare for the massive ensuing economic shock in three ways: (i) move exposure to the strongest companies and sovereigns (large cash buffers / limited short term debt / strong and defensible cash flow generation); (ii) position for emerging themes (physical to virtual / less outsourcing / less global supply chain / deglobalisation); (iii) keep cash on hand to take advantage of attractive opportunities presented by a big, but reversible, market failure. Investors should retain the potential for returns in case the Fed continues aggressively backstopping markets.
Markets and economies will rebound once there are effective methods for identifying and containing the spread of the virus, effective treatments are developed and immunity is increased. There remain substantial uncertainties relating to the duration and severity of the shutdowns. The longer the economic shutdowns continue, the greater the risk that otherwise healthy balance sheets become contaminated, making the subsequent recovery harder. Central bankers, governments and multilateral institutions should be ready to intervene accordingly.
Original Articles: https://www.ft.com/content/acc0414e-527c-43e2-826b-c87ab1fa5f79 and https://www.bloomberg.com/opinion/articles/2020-04-12/coronavirus-more-shock-and-awe-stimulus-may-be-needed
Mohamed El Erian is the former CEO and co-CIO of Pimco where, together with Bill Gross, he was responsible for building and managing the world’s largest global fixed income investment company including the actively managed $270 billion Total Return Fund.