El-Erian: Volatility is coming and here’s how to deal with it

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Many thought a robust U.S. economy could keep growth going despite weakness abroad, but a disappointing jobs report and softening economic data suggest otherwise. While stocks (^GSPC) have been climbing recently on anticipation that a Fed rate hike isn’t likely, these kinds of rallies typically do not portend the next leg up of a bull run.

The root for many of the markets current ills has been China. But are economic problems there, as well as the emerging markets, finally bringing problems here? Mohamed El-Erian of Allianz says it’s the other way around.

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“The root of all of our problems is that we cannot generate enough growth in the industrial world, and over time that has now contaminated the emerging world and that is feeding back onto the west,” he says in the attached video. “So we are in this low growth malaise with the balance of risk now having shifted to the downside.”

El-Erian believes we are in a “low-flation” environment, but that’s not the biggest risk to the U.S. economy and the Federal Reserve. “The biggest risk to the Fed is not on the inflation side, it’s not on the employment side, it is in terms of financial stability – to what extent has the Fed bought time at the risk of financial instability down the road. That’s the thing I worry most about.”

With lower rates a given and growth stalled somewhat, El-Erian believes we are transitioning from a low-volatility regime to a higher, but more normal range of volatility (^VIX). “First, prices start to move a lot more; secondly you start getting contagion – you have one asset class contaminated by the other and thirdly you get unpredictable correlations between asset classes,” he says, but there is a silver lining. “Investors have to be much more nimble – on the one hand they have massive opportunities to pick up good names at low prices, but when the markets rebound occasionally, as they will do, this is an opportunity to trade up in quality [too].”

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