El-Erian: Perspective on Dow 14,000February 4, 2013: 5:00 AM ET
Investors would be wise to temper their optimism with caution.
By Mohamed El-Erian
FORTUNE -- It is Saturday morning and I am sitting at a diner with my computer and coffee, waiting for my daughter to finish her activity. All around me, Dow 14,000 features prominently in newspapers; and I suspect it is also a common conversation topic.
Based on the interactions I have had in the last few weeks of this remarkable stock market run, I suspect that people around the country are trying to reconcile three related emotions.
The first is excitement, and lots of it.
It has taken the Dow almost 6 years to regain the 14,000 level. It did so by taking investors on a massive roller coaster – emotional and financial.
Now, new records are in clear sight. And, much more importantly, this translates into healthier 401k's, easier retirement planning for some, and less worry about college finances for others.
The second emotion is hope; and one that has been disappointed too many times since the onset of the 2008 global financial crisis and the harmful Great Recession that followed.
As wonderful as stock market rallies are, they don't mean much if they are not ultimately validated by a vibrant economy, lower unemployment and financial stability.
This week, the first preliminary economic growth estimate for the last (October-December 2012) quarter came at a disappointing -0.1% (1.5% for 2012 as a whole); and unemployment ticked up to 7.9%.
Fortunately, the vast majority of the other data releases have been much, much more encouraging.
Together, recent numbers point to the continuing, gradual healing of all major sectors except one – specifically, of the housing sector and labor market, and therefore households; of the financial system and corporate America; but not of the public sector except for a few States and municipalities here and there.
Then there is residual uncertainty, the third emotion that, for many citizens, has dominated the other two for much of the last 5 years.
While gradual healing remains the theme of the day, frustratingly it is yet to reach critical mass. With that, the economy is failing to attain escape velocity.
America needs its politicians to help, and do so by swapping self-created headwinds for tailwinds. Same for Europe.
Unfortunately, politicians both here and in many countries around the world seem more comfortable in – time and time again – kicking the can down the road rather than deal properly with economic challenges.
Indeed, if it weren't for the unusual activism of central banks, the Dow would be well below 14,000 today – well below. Also, the housing recovery would be less advanced and companies' balance sheets banks less healthy; and many of the banks fortunate enough to be still operating would be struggling to restore large capital cushions and decisively overcome bad legacy assets on their balance sheets.
Yet, as acknowledged repeatedly by Fed Chairman Ben Bernanke, central banks' policy experiments are far from costless. And adverse unintended consequences are not just possible; they are already apparent.
That is why central bankers around the world re-iterate that they are just providing a policy bridge (and certainly not a sustainable destination). They also appear less-than-fully confident when it comes to the when and how of the policy exit that will inevitably impose itself.
This brings us to Congress, a key political body that still seems comfortable in going from one fiscal squabble to another. In the process, it resolves very little; but it manages to divert attention and energy from other urgent policy priorities (such as helping to lower joblessness more rapidly, and materially improving the structure and functioning of the housing market, housing finance, education and infrastructure).
In Europe, the window of tranquility purchased by the central bank there has allowed for a return of policy complacency; and this after a previously-unthinkable existential risk to the Eurozone, the core of Europe's successful regional integration initiative.
As such, little is being done to counter a widening recession and improve a horrid unemployment situation, particularly among the young.
Because of this widespread political dysfunction, we (in the West) are yet to evolve our credit-dependent growth model into something more durable, inclusive, fair and sustainable. Instead, yet another attempt is being made to get one more turn of growth from an exhausted, distortive and partial approach.
So, how should you reconcile these emotions? I would suggest the following for you to consider:
- Temper your optimism with caution: There is a limit to how far central banks, acting on their own, can divorce market pricing from fundamentals.
- Identify the major developments that are needed to validate existing market pricing: This speaks to not just economic, sector- and company-specific issues; it also involves technical factors, including the scale and scope of funds flowing to different market segments.
That said, it is now time for me to go pick up my daughter and hear about her exciting morning!
Mohamed El-Erian is the CEO and co-chief investment officer of PIMCO. President Obama recently appointed El-Erian to head the U.S. global development council.