Barron's Streetwise - Mohamed El-Erian on Stocks, Bitcoin, and Zombies

Episode Date: June 5, 2020

Good news: The economy is reopening. Bad news: A top economist says Fed overreach could produce scary results. Learn more about your ad choices. Visit megaphone.fm/adchoices

With record levels of dry powder available for investment, find out what's in store for private markets in 2025 and beyond. Listen to Crafting Capital in partnership with UBS at partners.wsj.com slash UBS, Spotify and Apple Podcasts. The central bank shouldn't be in the business of picking winners and losers. And the central bank shouldn't be in the business of supporting zombie industries. loses and the central bank shouldn't be in the business of supporting zombie industries. Welcome to the Barron's Streetwise podcast. I'm Jack Howe. The voice you just heard, that's Mohamed El-Erian. He's the chief economic advisor of Allianz, the insurance and asset management giant. In a moment, we'll ask Mohamed what we should make of the stock market, bonds, the Federal Reserve, home buying, Bitcoin, summertime fashion trends. I might have forgotten to ask my fashion question

and all the excitement, but I got that other stuff. Mena, how much news have you been watching relative to how much you usually watch? I think my Twitter consumption is up like 150%. So you get the news from Twitter, you don't watch it on cable news? No, I mainly look online. If you watch on TV, it's been a week now since the death of George Floyd at the hands of a Minneapolis police officer. And we've had nationwide protests and civil unrest. And so you see these things unfold live. I can't breathe! I can't breathe! I can't breathe! I can't breathe!

But you also get in the little box in the corner of the cable news, they show what's going on with the stock market. And we've seen it rise just about every day. It's really hard to connect those two things in your head because you would think that one thing ought to explain the other, but it doesn't at all. Since we started this podcast in late March, we've told listeners to stick with stocks because trying to guess the short-term direction of the stock market is futile. And the past three weeks in particular have illustrated that point. The S&P 500 is up close to 8% over that time.

That's an incredible pace. If it continued at that pace, investors would well more than double their money in a year. Over those three weeks, we've had first a deterioration in the trade relationship between the U.S. and China, and now the protests. So what is driving stocks higher? Well, it could be that investors are looking forward to better news about the reopening. They can see that COVID-19 infections are falling in many cities, that businesses are opening back up. One report that caught my eye this past week is from Goldman Sachs. It tracks what it calls a

reopening index. It has all these measures of the kinds of things we do when we're staying at home, like watching news on TV and downloading video chat apps, and any other things we do when the economy begins to reopen, like fly on airplanes and make reservations for restaurants and shop at outlet malls. So the overall index goes from 1, which is fully locked down, up to 10, which would be fully reopened. The bad news is that we're still stuck at one. The good news is that in the report, Goldman's analysts say this is probably the last week we'll be at one. We're probably about to move to something higher. I'm not sure we'll all be popping the champagne when the index moves from a one to a two, but it's a start. Investors always want a neat story to explain why the stock market is going up.

I suppose you could say that the market is forward-looking and it's looking past the downturn right now and anticipating the reopening of the economy. Or you could say that interest rates are near zero and investors expect them to be stuck there for years to come so that stocks might be a better alternative than getting next to nothing in bonds and savings accounts. I'm not sure which is the right explanation, but for people who are wondering whether it's now time to sell stocks because they've rebounded so far, I'm going to continue to say no. But there's a disclaimer here. I always say that. When people ask me about what stocks are going to do, I always guess up. Not because stocks always go up, but because historically, they've gone up about two-thirds of the time over very short time periods,

and almost always over longer time periods. And I don't have any ability to predict the market's short-term direction, so I put the odds in my favor by guessing up. It's not a sophisticated approach, but it's easy easy and it's right more often than it's wrong. Meta, I feel like my always guess up approach to stocks is not very fancy and maybe it's the kind of thing I shouldn't put on a podcast. Do you want me to bleep it out? It's too late for that, but we should hear from someone with a more nuanced view than mine. And for that reason, I put in a call to Mohamed El-Erian.

Hi Mohamed, It's Jack Howe from Barron's. How are you? Hey, how are you? I started by asking what's behind the stock market's astonishing rebound. I think that it has been driven by two reinforcing factors. One is the notion that the market is very good at looking through the short term, and it's comfortable betting with an honorary return to some level of normalcy. And the data on the reopening so far is supportive of that hypothesis. And the second, perhaps more powerful element has been the notion that even if that is wrong, it doesn't matter because the Federal Reserve is able and willing to buy assets.

It has already indicated a willingness to buy high-yield assets. So if need be, it could even buy equities. So it's a win-win mindset that has powered the stock market to levels that are very hard to justify based on fundamentals. When Mohamed talks about levels that are very hard to justify, that sounds bearish to me. So I asked about whether investors should be worried about another downturn. The reality is we live in increasingly distorted markets, that those of us that believe that investing should be related in large part to fundamentals

are not comfortable at this stage. But if you are willing to bet on the Fed put, then you've got a very strong backstop. That is a very comforting notion to a lot of people. Let's look at one of the terms Mohamed just used, the Fed put. Now, a put is a type of option contract. It's a bet that an underlying security, like a stock, will go down in price. If I buy Coca-Cola puts, it means I'll make money if Coke shares fall. When someone refers to the Fed put, they're using a metaphor for the Fed's ability to turn bad news into good news. For example, in response to the pandemic for the Fed's ability to turn bad news into good news. For example, in response to the pandemic, the Fed lowered its core lending rate, called the Fed

funds rate, to near zero. That makes borrowing cheaper, and it typically lowers bond yields, making stocks look more attractive by comparison. The Fed is also buying trillions of dollars of bonds, including treasuries, mortgage-backed securities, even junk bonds, which are bonds issued by financially shaky companies. Muhammad also says investors are comforted by the Fed having a printing press. And that's another metaphor. He means the Fed can buy assets with a keystroke. It isn't constrained by needing to have money to pay for things. As you might imagine, not needing money to pay for things,

that does wonders for your buying power. I asked Muhammad if he thinks the Fed has taken the right steps to support the economy so far. The central bank shouldn't be in the business of picking winners and losers. And the central bank shouldn't be in the business of supporting zombie industries. So I was very supportive of what they did to the treasury market, to the money market, even to the investment grade market. But the step into high yield is the one that troubled me. And it's the one, by the way, that launched incredible confidence in the Fed port. Because once you go down to high yield, once you take on default risk, the next step to equities is a very small step.

Zombie companies. Now we're talking my language. I like anything with zombies in it. Meta, what's your favorite zombie movie? Oh my god, there's so many. 28 Days Later is good. Zombieland is good. There are a lot of good movies. There are two basic genres of zombie movies,

I think. There's the fast zombies and the slow zombies. Like Walking Dead, that's slow zombies, right? Yeah. So 28 days, those are fast zombies. You're into zombies who run. I'm into zombies who shamble. You know, I like a slower zombie, but you know, to each their own.

Slow zombies. Well, I'm a slower zombie. But, you know, to each their own. Mm-hmm. Slow zombies. Well, I'm not very athletic, all right? When Mohammed says zombie companies, he means weak companies whose share prices are artificially propped up, in this case by the Fed. He says there's a risk that we could go from zombie companies to zombie markets. And that's a problem because one of the jobs of the stock market is to separate winners from losers so that investors know where to direct their capital.

If suddenly all this is distorted, then there is cost in terms of market functioning, there is cost in terms of market efficiency, and therefore economic well-being. Every step you take further into distorting market has long-term costs and unintended consequences associated with it. Mohamed says that some investors sound as though they have a lot of clarity about what's next for stocks, and he contrasts that with companies suspending guidance or hints about what future financial results will look like. A company might report first quarter earnings of a dollar per share and then say as part of that report that based on current trends, we think we'll earn a dollar to a dollar ten in our second quarter. Now, not all companies give guidance even under

normal circumstances, but lately more companies have become reluctant to guess or unable to guess. According to FactSet, just 46 companies in the S&P 500 have given guidance for results for the quarter that runs through June. That's well below half the historical average. So Muhammad is saying if companies aren't confident enough to make forecasts, it's difficult for him to be confident. But then what about bond yields being so low? I saw recently that more than 90% of government bonds across developed markets have yields below 1%. Doesn't that make stocks more attractive by comparison?

Here's Mohamed. It is part of the Fed wanting us to take more risk, wanting us to push up asset prices as a way, they hope, of stimulating the economy. But I remind them of the story of the person who calls their friend and says in a very excited tone that they bought a dog for $40,000. And the friend says, you did what? You paid $40,000 for a dog? And the other one responds, yeah, it was a great deal. The cat was selling for $40,000 for a dog. And the other one would respond, yeah, it was a great deal.

The cat was selling for $50,000. So even the relative trade has its limits. Mohamed says it's a good time to get defensive, which could mean shifting some money away from stocks. For bonds, he recommends going up in quality, even if that means sacrificing returns. Mohamed contrasts the economic shock of the pandemic with the global financial crisis just over a decade ago. He says economic shocks like the current one, they could take much longer to reach critical mass, but when they do, they can be hard to unwind.

It's a cautious view, to say the least, and it helps explain why Mohammed isn't worried about inflation in the near term, even with policymakers spending so much money on stimulus. So it is very difficult to generate inflation in the short term. You can do it for certain sectors, but you can't do it economy-wide, and that's because demand is so beaten up. economy-wide, and that's because demand is so beaten up. We're going to have problem recovering on the demand side. Economic insecurity, household insecurity is very high. People are not sure about what their future income looks like. Okay, so at least inflation is one thing we probably won't have to worry about right away. Unfortunately, that's because demand is depressed, which might not be great for stocks. But what about this?

What about shifting money from U.S. stocks to overseas stocks because valuations are lower in other developed markets? Mohamed says this is no time, as he puts it, to fade the U.S. The time will come for that trade. It is not now. And valuations continue to do better in the U.S. than they did in the rest of the world. I think we're still in that stage. In my view, you only fade the U.S. for the rest of the world if you believe we are on the cusp of a major global economic recovery.

If you don't, then you've got to ask yourself, which economy has higher resilience? And it is the U.S. by far. Meta, I have an idea. All right, let's hear it. If U.S. stock prices are high and overseas stocks don't look great, and if bond yields stink, maybe I should pull money out of the stock market and buy a giant house, like three times the size of the house I live in now. I could probably get my wife to go along with the idea and the kids would think I'm really cool. It would be a little bit squanderous, but all you do is you put something relative to the 10-year

treasury yield and it looks better. So if it's squanderous relative to the 10-year, it's only a little squanderous, right? What do you think? I think that sounds pretty good. it's only a little squanderous, right? What do you think? I think that sounds pretty good. Well, I asked Mohamed and he trampled on my dream a little bit. He says, consumers and investors have already committed too much money to real estate and that a weak economy could send prices lower, creating buying opportunities down the road. Whether it is apartment buildings in New York or commercial real estate. There's going to be opportunities because there will be people needing absolutely to get out of leases, needing to do all sorts of things. Sounds like I better stay in my regular size house and keep saving and my kids probably

won't think I'm as cool. But Meta, I think we should take a closer look at housing in another episode. What do you think? I think that's a good idea. In literature, they call that foreshadowing. In podcasting, they call it hinting without committing to a future episode. One last question for Mohamed. I asked about Bitcoin. Why Bitcoin? Because Mohamed sounds so cautious on traditional assets like stocks,

and Bitcoin was the most speculative thing I could think of. So I thought it'd be fun to hear him just tear into it the way it's sometimes fun to read a review of like a really bad movie or restaurant. The writer just delights in taking it down. So go ahead, Mohammed. Let those Bitcoin bulls have it. So I bought Bitcoin to $3,000, but I really bought them because I was interested in understanding what they do, etc. If you're buying Bitcoins because, like me, you believe that they

will exist in the ecosystem, they'll exist, right? There'll be some degree of adoption, but it's not going to be the universal adoptions that the advocates claim, then it makes sense for you to have some Bitcoins to 3% in your portfolio. That did not go like I thought. I was looking for a takedown. That was like a harsh restaurant critic who decides, you know what, that 7-Eleven chili dog was pretty good. Meta, did Mohammed say he bought Bitcoin at $3,000? I think that's pretty good, right? I think it's over $9,000 now. He's crypto cashing in over there. Anyhow, there you have it.

Mohammed is pretty cautious on stocks and the economy, but he's not quite doom and gloom, and he likes the U.S. more than overseas markets. He doesn't expect inflation soon. He doesn't think I should buy a humungo house, and he's not altogether opposed to buying just a smidgen of Bitcoin. As for me, I'm still guessing up on stocks. I'm not there yet on Bitcoin. And I think I could go for a chili dog. question? We do. We've got one from Mohit. He's sending his message from Washington, DC. Should I say let's hear it or do you want to say let's hear it? Let's hear it. You know what? He or she who hesitates is lost, Meta.

Sorry, Meta, that was rude of me. You say it. Let's hear it. What she said. Let's hear it. What she said. Since I'm new to investing, I'm thinking of basically maxing out my 401k at first and then using the money to basically buy some S&P 500 index funds. So would you be able to go into a little bit about what could be some of the possible trading platforms where we could perform such purchases. Thank you. Thank you, Mohit, for the question. I think you're off to a great start with a 401k. That is the place you want to start because the money there grows tax deferred and often you get a match on the money. It's like free money. So when you want to invest more outside of that, you say you want to buy an S&P 500 index

fund. And I think that's another good idea because fees for those are typically very low. And you're wondering where you can go to do that. This is going to be an easy question for me because Barron's has done the work. Each year they rank online brokers. Their latest ranking they published in February. And they break it down. What's best for mobile it down what's best for

mobile traders what's best for international traders for active traders but they have one section for buy and hold investors which is what it sounds like you will be and there they list Fidelity and Schwab as being among their top picks that's a good place for you to start and both Fidelity and Schwab have in-house brands of S&P 500 funds that have very low fees. Thank you, Mohit from Washington, D.C., for your question. And everyone, please keep the questions coming. Just tape on your phone. Use the voice memo app. Send an email to jack.how, that's H-O-U-G-H, at barons.com. Send comments too. You agree with me? You disagree? You like Meta more than you like me? Everyone says that. Anyhow, I can take it. Thank you for listening. Meta Lutsoft is our producer. Subscribe to the podcast on Apple

Podcasts, Spotify, or wherever you listen to podcasts. If you listen on Apple, please leave a review. Follow me on Twitter to find out about stories and new podcast episodes. That's at Jack Howe, H-O-U-G-H. See you next week.