Four things that could burst the “rational bubble” in stocks: Mohamed El-Erian
There has been a lot of commotion over the stock rally. With significant averages consistently setting new records, the S&P 500 rose another 1.5% after last year’s 16% gain, and the seemingly bottomless appetite for IPOs and After-sales service (Special Purpose Acquisition Company), investors want to know: what could cause stocks to fall?
Mohamed El-Erian believes path of least resistance continues to rise as stocks float in a “rational bubble,” a phenomenon described in a Financial Times item earlier this year.
But there are four risks to the continuation of the rally. El-Erian, president of Queens College at Cambridge University and chief economic adviser to Allianz, described these risks in an interview with Yahoo Finance Live.
First, the least likely risk is that the Federal Reserve withdraws its monetary stimulus. But as Fed Chairman Jay Powell said last Thursday in a webinar: “Be careful not to go out too early. “
El-Erian believes that if the Fed’s public reason for keeping the taps open is concern about a weak economic recovery, there is also a less explicit reason: “They don’t want to repeat the temper tantrumHe said, referring to the sharp rise in bond yields in 2013 following comments from the Fed that it would start cutting stimulus.
“They are concerned that higher yields will alter the appetite for stocks,” El-Erian said. “They don’t want stock market volatility to undermine the economy.”
So, no reduction for the moment.
The next risk: a wave of corporate bankruptcies. “It’s going to happen to some extent, but not enough, I think, to change the behavior of the markets,” El-Erian said. Indeed, more than 600 companies filed for bankruptcy last year, including well-known consumer names like Lord & Taylor and CEC Entertainment, the parent company of Chuck E. Cheese. But the stock markets remained unfazed.
The last two risks could be more, well, risky.
There could be “some sort of market crash.” We see a lot of risk taking, ”said El-Erian. It’s reminiscent of the 1999 crash, when tech startup valuations soared and then collapsed as investors were willing to pay high prices for estimated future growth.
Some investors are seeing echoes of this dot-com bubble today, with a record fourth quarter for IPOs continuing to gain momentum into 2021. Lender Affirm went public on Wednesday, its shares have almost doubled. Shares of Poshmark, an online marketplace for second-hand goods, rose more than 130% when it debuted on Thursday.
To monitor final risk, watch the bond market.
“If we were to see another 20 basis point change in yields, that would be bad news,” El-Erian said.
This is because one of the driving forces behind the stock rally is the idea that “there is no alternative”, frequently referred to by its acronym, TINA. If bond yields rise more significantly, this could be an attractive alternative to equities.
Investors can keep an eye on these risks while recognizing that stocks are likely to continue to rise.
“To be clear, the path of least resistance right now is higher,” El-Erian said.
Julie Hyman is the co-host of Yahoo Finance Live, weekdays 9 a.m. to 11 a.m. ET.