Mohamed El-Erian, CEO and co-CIO at Pimco, says emerging markets remain at risk of capital outflows. This is an excerpt of a bigger interview with El-Erian in FinanceAsia, our sibling title, which appears in its October magazine.
Where in the global marketplace do you see the most attractive risk premiums?
Let me answer it another way: the first way to make money is not to lose money. Asset markets have been riding an enormous wave of central bank liquidity. Some markets, such as emerging-market equities, have corrected. So has the front end of the US Treasury yield curve. Other markets haven’t corrected, and investors are still riding the wave of liquidity. Like a surfer riding a wave, these people will need to kick out of it safely: a surfer doesn’t wait until the end of the wave to leave, especially if the wave is crowded with other surfers.
So what asset classes have yet to correct?
US equities are a really big wave. Some investors think they have a put on equities thanks to the Fed, but I would be careful.
What about emerging market debt?
When tourists leave, they leave in an indiscriminate fashion. One of the best ways to think about this situation actually goes back a long way, when the idea of asymmetrical information was developed around the ‘market for lemons’. The original idea was about second-hand cars: no matter how well maintained a second-hand car may be, when there’s so many stories or speculation about people trying to pass off shoddy cars – lemons – the honest seller can’t signal that in a credible way. In such an environment, any car will trade like a lemon.
For emerging markets, continuous liquidity shocks out of the West is making it difficult for better markets to make themselves credible, so they tend to trade like lemons.
Surely these investors aren’t that foolish.
There are technical reasons for their behaviour. When investors redeem out of emerging-market funds, those portfolio managers have no choice but to take money out of markets across the board. What that means, of course, that there is a good opportunity for those investors willing to differentiate among markets.
On what grounds?
Balance sheet strength – looking at things like cash reserves and levels of debt – plus liquidity and exposure to engines of growth.