TheChek News Flow

Pimco’s El-Erian: U.S. Could Become Japan

Mohamed El-Erian, the outgoing CEO and co-CIO at Pimco, said at a conference Thursday that the U.S. was in danger of "becoming Japan" if Congress cannot get over its dysfunction and take action to spur growth. El-Erian, speaking with CBS business analyst Jill Schlesinger at a LinkedIn conference in Manhattan, warned that the U.S. economy cannot be supported forever by the Federal Reserve alone.

At the outset of the discussion, El-Erian said with a laugh that he had written a "boring speech," but that Schlesinger wouldn’t let him deliver it, so he posted it on LinkedIn and answered her questions instead. Her first question of course, was what he planned to do after leaving next Pimco next month, and he didn’t offer many details. He said he was "very interested in the intersection between Main Street, Wall Street, and policy."

El-Erian covered a lot of ground, from his affection for Janet Yellen to an explanation of why Fed policy has an outsize effect on emerging market economies. On Yellen: "She really cares about unemployment, she really cares about inequality." On emerging markets: "Why do so many lottery winners end up bankrupt?" he asked. Emerging market economies were not equipped to handle the massive influx of dollars that flooded in when the Fed was easing, or the resilience to withstand the sudden outflow when investors feared an end to easy money.

But mostly the discussion kept coming back to the U.S. economy. Looking back on the financial crisis, which he said was largely created by a love affair with debt, he emphasized the severity of the downturn with a Monte Python reference – it was "not a flesh wound," he said. Realizing that massive deleveraging would be needed to improve corporate and personal balance sheets, he said, and that the reduced spending would slow economic growth for years, "we came up with this silly term, the ‘new normal’."

He identified four ways for the nation to escape debt: First, and by far best, is to grow out. Second, default, which he said would come at huge cost. Third, austerity, which he said was not working out too well in Europe. (Though he did predict growth would improve to 1% on the Continent this year.) And fourth, the current course: artificial stimulus from the central bank.

While he credited the Fed’s first round of quantitative easing with saving the economy, he said QE 2 and its subsequent iterations were very different, and that the "costs and risks are starting to get close to the benefits."

"The Fed has the willingness to help, but it doesn’t have the tools," he said. "But with a polarized Congress it’s impossible to solve the problems." How to stimulate growth, "that is how the debate over debt should begin and end." Though he avoided specifics, he did suggest Congress would need to spend more, not less, presumably in the short term.

And without any acknowledgement that the term has become politically charged, El-Erian declared that inequality was holding back the economy as well. "It is not just inequality of income, or inequality of wealth, but inequality of opportunity," he said, pointing out that the unemployment rate for college graduates is 3% while it’s above 10% for those without a degree.

While he declined to predict where the market was headed, he is confident the road will be rocky. "So if you are an investor you’d better get ready for volatility," he said. "You’re going to get more of it… Come up with a plan for the worst-case scenario. Volatility plus human nature means you are going to do the wrong thing at the wrong time."

Weekly Market Update: Yellen and Boehner Send US Equities Back toward All-Time Highs

- Global equity markets saw a solid run of risk-on trading this week. In the US, newly-installed Fed Chair Janet Yellen said all the right things in her first public report to Congress, pledging continuity with the policies pursued by Ben Bernenke. House Speaker Boehner surprised markets and his own party by proposing and then forcing through a clean debt ceiling increase, with no conditions. In the eurozone, a raft of slightly better-than-expected preliminary Q4 GDP reports helped support the emerging slow European recovery thesis. With snowstorms disrupting life up and down the US east coast, trading volumes were on the low side for most of the week, supporting a stronger, quicker move higher in equities. The S&P500 closed out the week within striking distance of the recent all-time high of 1,850. For the week, the DJIA rose 2.3%, the S&P500 gained 2.3% and the Nasdaq added 2.9%.

- In testimony before Congress, Yellen pledged her support for current FOMC policy and emphasized that there would be a great deal of continuity in monetary policy from Bernanke's tenure. Yellen repeated Bernanke's constant refrain that rates would remain near zero until well past the 6.5% threshold comes and goes. On QE, Yellen reflected the committee view that it would take a notable change in the outlook to alter the trajectory of tapering, though left leeway by reiterating that the taper is not on a pre-set course. Regarding the recent payrolls weakness, she said she was surprised the Dec and Jan reports came in below expectations but also said one cannot jump to conclusions based on two reports impacted by terrible winter weather.

- The "clean" debt ceiling hike may very well go down as the moment when the budget wars of the last several years ended in truce. The Speaker's move prevented another protracted and damaging battle and authorized the national credit card through March 2015.

- Spot gold prices have gained approximately 3.5% over the last week, and the metal crossed above its 200-day moving average on Friday for first time in a year. Gold has seen a steady recovery since early January, and the catalysts behind the leg up this week are somewhat opaque, with continued emerging market weakness, a softer dollar and even the cyber-attacks on bitcoin exchanges being cited. However, some analysts suggest it will take more than short-term technical moves to propel the yellow metal very far beyond the $1,300 level. Copper hit three-week highs this week, rising to $3.265. Silver gained a whopping 5% on Friday alone. Crude spent almost the entire week in the $100 handle, but the big gains in the front-month contract all arrived last Friday, post payrolls.

- January US retail sales slipped lower m/m even as the December result was revised lower, into negative territory. The disappointing data dampened the risk-on tone in markets on Thursday, however the reason for the slip is pretty obvious at this point: icy weather. The same excuse for weak results was behind the January jobs report and has been repeated by nearly every CEO in a consumer-exposed business for all of the current earnings season. The biggest negative component in the retail report was weak January auto sales, a factor which had already been disclosed in US January sales numbers out of the major auto manufacturers last week.

- Time Warner Cable agreed to Comcast's all-stock merger offer, valuing the cable giant around $45.2 billion, and spurning Charter Communications $132.50/share offer. The deal combines the two largest US cable TV companies in an entity with 30 million subscribers, and is practically guaranteed to draw lots of anti-trust attention. To assuage these concerns, Comcast has pledged to divest 3 million subscribers after the deal closes, but notably the deal did not include any breakup fee, and Time Warner shares are trading at more than a 5% discount to the deal price.

- Discomfort with the future of Cisco has only deepened after its latest quarterly revenue decline. Cisco's revenue slid 8% y/y in its second quarter, and it said it would slide another 6-8% in its third quarter. CEO Chambers pounded the table, citing a book-to-bill greater than 1.0 and the best booking backlog the company has seen in years. Cisco shares lost 4.5% after reporting on Wednesday but recovered nearly all of the losses in the back half of the week. Meanwhile, two other tech hardware names, Applied Materials and Nvidia, surged to new 52 week highs after issuing strong quarterly reports.

- Deere topped consensus expectations in its first quarter report, on very modest y/y gains in income and revenue. The firm reiterated it glum forecasts for FY14, with total sales seen down 3% y/y, on flagging global demand. One bright spot was the outlook for construction and forestry, as the rebounding economy in the US and Canada spurs more housing starts.

- Italian Prime Minister Enrico Letta has been thrown out of office by the leader of his own party, Matteo Renzi. The young, ambitious leader of the center-left Democratic Party, Renzi claimed that electoral and employment reforms were getting mired in political paralysis and felt compelled to push Letta out. The move gives Italy its third government in the last 12 months, though Renzi got assurances from the erstwhile opposition that they would continue to support the ruling coalition. Yields on 10-year Italian government bonds fell to their lowest levels since early 2006, around 3.68%, reflecting the lack of concern over the developments in financial markets.

- EUR/USD rose to its highest levels in two weeks and very nearly matched YTD highs from early January, around 1.3715. The ECB monthly report trimmed its outlook for Eurozone inflation in 2014 and 2015, however the initial 2016 forecast was for harmonized CPI at 1.7% in 2016, backing Draghi's repeated assertions that there will not be deflation in the Eurozone. Recall that in last week's post-ECB decision press conference, Draghi specifically cited the need to have these initial 2016 forecasts in hand before making any more decisions about cutting rates further. Decent preliminary Q4 GDP reports from core members France, Germany, and the Netherlands as well as peripheral nations Italy and Portugal also helped support the euro.

- The Bank of England's quarterly inflation report was seen as a bit more hawkish than expected in maintaining the 7.0% unemployment threshold (with the latest unemployment reading at 7.1%). The report also suggested the BoE's new forward guidance would monitor a broader range of economic indicators, without being too specific about which indicators were being watched. Sterling firmed as analysts decided the BoE will tighten policy sooner than it would loosen it. GBP/USD hit highest level since May 2011, above 1.6700.

Closing Market Summary: Stocks End Strong Week on Upbeat Note

The stock market ended an upbeat week on a positive note. The Dow Jones Industrial Average (+0.8%) paced the advance while the S&P 500 gained 0.5%. The Nasdaq (+0.1%) lagged, but was able to finish at its highest level since late 2000.

Today's advance capped an impressive week during which the benchmark S&P 500 gained 2.3%. Even though stocks rallied sharply, it is worth noting that all five sessions of the week saw below-average volume while bellwether groups like financials and transports struggled to keep pace with the broader market. The financial sector added just 0.2% on Friday, extending its weekly gain to 1.6%. For its part, the Dow Jones Transportation Average (+0.3%) added 0.9% for the week.

Similar to financials, other top-weighted sectors like health care (+0.4%) and technology (+0.2%) lagged while consumer discretionary (+0.6%), energy (+1.5%), industrials (+0.7%), and materials (+0.7%) picked up the slack.

The energy sector drew considerable strength from its largest member, ExxonMobil (XOM 94.11, +2.68), which surged 2.9%. The Dow component regained its 100- and 200-day moving averages in a move that was aided by an ISI Group upgrade to ‘Buy' from ‘Neutral.' On a related note, crude oil ended little changed at $100.29/bbl.

Elsewhere among commodities, precious metals remained on a torrid pace. Gold futures posted their seventh day of gains, climbing more than 5.0% in that timeframe. Meanwhile, silver capped an eight-day run that saw the metal jump nearly 8.0%. This translated into another strong session for gold miners as the Market Vectors Gold Miners ETF (GDX 26.35, +0.48) rose 1.9%.

Mining shares contributed to the outperformance of the materials sector, which also benefitted from gains among steelmakers after Cliffs Natural Resources (CLF 23.16, +1.26) reported better-than-expected results.

Staying on the earnings theme, apparel retailer V.F. Corp (VFC 56.85, -3.04) slumped after announcing disappointing results and issuing a profit warning. The stock tumbled 5.1%, which kept a lid on its peers. The rest of the discretionary sector held up well with help from homebuilders. The iShares Dow Jones US Home Construction ETF (ITB 25.21, +0.28) rose 1.1%.

Interestingly, builder shares outperformed even as Treasury yields inched higher. The benchmark 10-yr yield rose one basis point to 2.74% after ending last week at 2.68%.

As mentioned earlier, trading volume was well below average with only 609 million shares changing hands at the NYSE. Today's final tally represented the lowest total since January 3.

Today's economic data included three reports:

* Export prices, excluding agriculture, ticked up 0.2% in January after increasing 0.3% in the prior reading. Excluding oil, import prices rose 0.3%, which follows last month's downtick of 0.1%.  * Industrial production declined 0.3% in January after increasing 0.3% in December while the Briefing.com consensus expected an increase of 0.3%. Once again, the hard economic data did not mesh with the results in the ISM report and the related regional surveys. Those reports showed solid, albeit slightly unsteady production levels in January.

Instead of translating into slightly positive growth, however, actual manufacturing production fell 0.8% in January. That was the largest drop since May 2009. Making matters worse, manufacturing production growth was revised down for each month going back to October. After the revisions, fourth quarter manufacturing production only increased 4.2%, down from an originally reported gain of 6.2%. This comes after the ISM Production Index was recorded above 60 during that entire time, suggesting manufacturers are definitely not doing what they are saying in the surveys. The motor vehicle sector was hit especially hard in January. Assemblies fell by 1.0 million, from 11.64 million in December to 11.62 million in January.  * The preliminary reading for the University of Michigan Consumer Sentiment Index for February was unchanged at 81.2 while the consensus expected the index to fall to 80.2. The Current Conditions Index weakened slightly, falling from 96.8 in January to 94.0. This was offset by an increase in the Expectations Index from 71.2 to 73.0 in February. 

Bond and equity markets will be closed on Monday for Presidents' Day.

* Nasdaq Composite +1.6% YTD  * S&P 500 -0.5% YTD  * Russell 2000 -1.1% YTD  * Dow Jones Industrial Average -2.6%