When Markets Collide (Mohamed El-Erian) 6 comments
Mohamed El-Erian has had one hell of a career. He was a university academic, worked in the IMF for 15 years, went to work at PIMCO --- the world's largest bond fund --- alongside the legendary bond king Bill Gross, left to manage Harvard's multi-billion dollar endowment, then returned to PIMCO to share equal status with Gross as co-CIOs (chief investment officer). He is now one of the most respected investment gurus whom the public seldom hear about, though he is coming more into the public eye, through his regular commentaries on CNBC and the like. His first book thus warrants a read, especially when it comes concurrently with the "greatest financial crisis since the Great Depression" (as the media like to coin it nowadays).
Many books start off promisingly and then start to lose the reader's interest as they ramble on, and I'm afraid that this one is not an exception. The premise of the book is about the growing importance of emerging markets and the possibly turbulent transition process, hence the title "When Markets Collide" (ie. collide with the incumbent dominant Western markets), with the current financial crisis as a potential catalyst. El-Erian speaks authoritatively because he was dealing with emerging markets at the IMF and PIMCO, and the starting chapters are indeed very interesting, as he outlines his observations of various anomalies in the past few years, such as how long-term bond yields rose even as the Fed raised interest rates in 2005. He also highlights the importance of picking up information signals from apparent noise, in order that one may make sense of these anomalies. Then he defines the new destination: emerging markets.
According to El-Erian, the destination ie. the way that the world will evolve into over the medium to long-term, differs from the present in three main ways:
(1) For those seeking to understand global economic and financial developments, it will no longer be sufficient to get the US, Europe and Japan right. It will also be a matter of getting the emerging market economies right.
(2) New pools of capital, in particular sovereign wealth funds (SWFs), will become increasingly important and people need to understand what and why these new investors are likely to buy.
(3) Fundamentals will no longer be sufficient for projecting forward. Financial innovation via derivatives means it is also necessary to understand how the technical dimensions of markets are evolving ie. the financial infrastructure, the interactions between derivatives and underlying assets.
These predictions are justified correspondingly, through descriptions of how consumption of commodities, world trade have become increasingly dominated by emerging economies, how these economies have accumulated huge surpluses, and how securitisation has changed business models forever.
Having defined the destination, the rest of the book then goes on to describe the journey to get there, which El-Erian says he is less sure of than the eventual destination. In short, the medium-term evolution is more difficult to anticipate than the long-term destination. He does point out that there are likely to be "market accidents" ie. undesirable market volatility, given such a historic transition. My attention started to waver from this part onwards, especially when El-Erian talks about "action plans for policy makers and global institutions" and macro suggestions for "improved risk management" ---- topics which are very dry and not very relevant to me as an investor --- hence my earlier observation on the book being interesting at the start and disappointing towards the end.
Some of his views that are pertinent to the investor are interesting to note though:
(1) He advocates equity exposure away from the US and towards emerging markets. He believes there should be strong exposure to commodities, infrastructure, real estate ("real assets") in view of the new secular realities. Interestingly, he seems to recommend underweighting bonds, surprising since he works in bond specialist PIMCO. I might be mistaken.
(2) He sees emerging economies' macro policy evolving in a 4-phase process: benign neglect --> sterilisation --> liability & asset management --> embracing change. In essence, emerging economies that find themselves changing from operating in debtor regimes to operating in creditor regimes tend to be initially conservative in the management of their new-found foreign reserves, but will eventually realise the permanence of this structural change and manage their assets and policies proactively. El-Erian sees bond markets losing favour with these SWFs and equities gaining. Currency regimes could also become more open.
(3) He points out in fact, policymakers around the world already share a consensus on what constitutes a correct macro-policy response to facilitate the realignment of national economies and smooth functioning of the international financial system. This is as follows: the US is to reduce consumption to allow for a reversal of trade and budget imbalances; Europe and Japan are to implement reforms that will allow their economies to increase growth capacity and productivity; Asia and the oil exporters are to stimulate domestic components of aggregate demand. This coordinated response would reduce global imbalances and reduce financial system instability over the long term. However, all this must be done together; no country will want to implement this in isolation as it would be impacted negatively --- a classic "prisoner's dilemma". Perhaps this is what the G-20 are assembling for this weekend and will eventually work towards over the next few meetings.
A word of caution though: already El-Erian's expectation of emerging markets behaving relatively stronger than developed markets has turned out to be apparently wrong so far because in fact the flight to safety plus the deleveraging process has subjected the former to greater stress than the latter. It remains to be seen whether his long-term views will come to pass, but of course they carry a lot of weight.
Those not too well-versed in macroeconomics might find this book a bit hard reading. I myself have a general understanding but feel more at home in sectoral and company analysis, and I did lose interest at certain junctures of the book. I nearly did not buy it but eventually did, because it's this guy's first book and he'd probably have put a lot of honest thoughts into it.