September 15th: The Day the Earth Stopped

Mohamed El-Erian made an appearance on CNBC's Fast Money to discuss the state of the markets. He does not think the move into Treasuries was irrational, but points out they will get smashed when investors risk appetites return, as they seek out corporate bonds and, further out on the risk curve, equities. Sensible advice for sure, much like his thesis on financials earlier this year, which kept you out of trouble if you listened. He looked for a bottom in financial stocks to occur only after individual stocks, and the industry, had been recapitalized:

June 2nd
In an interview, which essentially summarizes the position El-Erian and Pimco have been taking for months, El-Erian lays out the one, and only, case for these stocks.

Business is unlikely to materially improve near term, and banks and brokers still need to right size their organizations (Ie. layoffs), until the financials are done with their recapitalization efforts, buying the equity remains dangerous.

Lehman never got a recap done - indeed, stock melted down faster than I thought. Discussions with Korean bankers when the stock teetered in the teens bordered on bizarre, and the minute the discussions ended the stock imploded to the single digits.

But the worse was yet to come...and it will be a long road back as we clean this mess up, according to El-Erian:

History books will document that the global economy experienced a sudden stop after September 15. In accentuating long-standing structural weaknesses, the manner in which Lehman Brothers failed disrupted the trust that underpins the smooth functioning of market economies. As a result, virtually every indicator of economic and financial relationships exhibits characteristics of cardiac arrest.

The situation will get worse before it gets better and it will only get better if there is a shift in thinking in both the private and public sectors: away from comforting yet unrealistic notions of a return to “business as usual” and towards the more nasty reality of a volatile journey to a different destination. The implications are far-reaching as they speak to more market accidents, disorderly sectoral realignments and additional shifts in policy.

Although he is looking for a 4% contraction in GDP, he is concerned with the fragile state of confidence as well:

Without further adjustments, there will be an aggravation of the negative feedback loops that have been so detrimental to global welfare.

Mohamed discusses four principles the should underlie the healing, and where it might be appropriate for the government to intervene, in his latest Op-Ed in the FT.

First, intervention should be limited to sectors at the centre of the healing process, thereby supplementing recent success in the commercial and money markets with the gradual normalisation of the housing and financial sectors.

Second, wherever they can, governments should partner the private sector which, in most cases, would involve voluntary co-investments, but in some cases (such as US cars) may require co-ordinated burden-sharing among stakeholders. Third, they should address upfront exit mechanisms. Finally, they should not let the best be the enemy of the good: crisis management inevitably results in inconsistencies that a subsequent reconciliation and reform effort must address.

Mohamed knows that some government intervention in necessary, but hopes it will be minimized, and we get them out of our hair later.

You might not want to change your thinking, but face it, the old days are a memory. Prepare to deal with it, and check out his latest missive in the FT, which discusses how the failure of Lehman really got the ball rolling to the downside.

Only new thinking will save the global economy
Financial Times

Mohamed El-Erian Knows When to Buy the Financial Stocks
1440 Wall Street
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The content contained in this blog represents the opinions of 1440 Wall Street. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.

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