One-on-One with Mohamed El-Erian

It’s not every day that you are fortunate enough to interview a world-renowned economist, but that’s just what happened to me last week. I sat down with Mohamed El-Erian, the soon-to-be former CEO of PIMCO at LinkedIn’s FinanceConnect 2014. Over the course of nearly an hour, El-Erian outlined his thoughts on the global economy, Federal Reserve policy (and new chairwoman Janet Yellen) and what ordinary investors should be doing right now. The good news is that El-Erian believes that for Main Street, 2014 will be a better year than 2013. The bad news is that while the recovery continues, the economy faces three major issues: a debt overhang from the boom and bust, a labor force that requires re-tooling and an outsized reliance on households to drive growth. The combination has pushed the US towards what he calls a “T-Junction”: As the economy approaches the intersection, it can veer in one direction, where the system will continue to heal; or in the other direction, where growth remains low and consumers and the government remain under pressure due to heavy debt loads. El-Erian put the odds of either outcome at a sobering 50-50.

When I asked about the nation’s debt problem, he responded with four potential solutions: (1) Grow our way out (the best case) (2) Default (see: Detroit) (3) Austerity (see: Europe) and (4) Rely on “artificial stimulus” from the Federal Reserve (see: US from August 2010-present). El-Erian acknowledged that while the first solution would be the best, it requires participation from lawmakers. Without Congress, the Fed’s monetary policy has become the next, best solution, at least in the short-term.

The problem with the Fed’s current policies, according to El-Erian, is that as we move further from crisis mode, the cost and risk of highly accommodative policy outweigh the benefits. In other words, it’s one thing to rely on zero percent interest rates and bond buying to normalize markets amid a financial upheaval, but five+ years later, the risk of asset bubbles exploding becomes more threatening than the potential that the wealth effect will further boost economic growth.

On the positive side, El-Erian believes that Janet Yellen is up to the task of unwinding the policy she helped create. He said that she was not only a “qualified economist” with “a passion for policy,” she was also “caring, gracious and inclusive.” That said, the removal of liquidity from the system is bound to create more volatility for investors and he warned anyone with money at risk in the markets to “Come up with a plan for the worst-case scenario,” and determine which mistake you can avoid making, because “Volatility plus human nature means you are going to do the wrong thing at the wrong time.”

MARKETS: Investors chalked up weak data to the severe weather and drove stock indexes to their best week of the year. Emerging markets, where much of the winter turmoil began, are up 6.9 percent since the Feb. 3 lows.

• DJIA: 16,154, up 2.3% on week, down 2.5% YTD
• S&P 500: 1838, up 2.3% on week, down 0.5% YTD (+5.6% since Feb 3 lows)
• NASDAQ: 4244, up 2.9% on week, up 1.6% YTD (Highest close since 7/17/00)
• 10-Year Treasury yield: 2.75% (from 2.68% a week ago)
• Feb Crude Oil: $100.30, up .4% on week
• April Gold: 1318.60, up 4.4% on week
• AAA Nat'l average price for gallon of regular Gas: $3.39 (from $3.64 a year ago)

THE WEEK AHEAD: After the day off, a fresh round of data from the nation’s real estate market is due. The pace of activity is expected to slow, with sales likely dropping by over 5 percent from year-ago levels. Part of the fall-off is likely attributable to the current goat - bad weather, though housing experts note that the slowdown should be expected, because last year’s rapid pace is simply not sustainable.

Economists are trying to determine the effect of the severe weather on the economy. While most statistics are adjusted to strip out normal seasonal patterns, a challenge arises when winter weather is much worse than normal, like the recent spate that the nation has experienced. Economists believe that Q1 growth is likely to drop by an annualized 0.3 percent to 2.2 percent. The good news is that after the weather returns to normal, consumers might unleash pent-up demand, helping to spur a marked improvement in overall economic activity.

Mon 2/17: US MARKETS CLOSED FOR PRESIDENT’S DAY

Tues 2/18:

Coca-Cola, Herbalife

8:30 Empire State Manufacturing Index

10:00 NAHB Housing Market Index

Weds 2/19:

Tesla

8:30 Housing Starts

8:30 PPI

2:00 FOMC Minutes

Thurs 2/20:

Groupon, Hewlett-Packard, Nordstrom, Wal-Mart

8:30 Weekly Jobless Claims

8:30 CPI

10:00 Philadelphia Fed Survey

Fri 2/21:

10:00 Existing Home Sales

Sat 2/22

G-20 finance ministers meet in Sydney, Australia