There was a great interview with Mohamed El-Erian this morning on CNBC. El-Erian always presents a well though-out, articulate, and accessible perspective on various financial issues. This morning's interview was no different as he discussed the recent market rally and whether the economy is beginning to recover. As for the recent moves in the stock market, El-Erian believes that the run-up in prices, especially the July portion of the equity market rally, is part of a "sugar high," implying a correction is in order. As for the economy, El-Erian believes the current optimism is based on some false assumptions, including:

• Corporate profitability can be maintained with additional cost-cutting. Not true. You need revenue growth.
• The stimulus spending will have a permanent effect. Not true. Just look what happen in China on Wednesday when they decided to cut-back stimulus spending.
• The stabilization of housing is sufficient to get the economy growing again. Not true. A housing recover is necessary, but is not sufficient by itself.

El-Erian goes on to say that what we need is final demand, producing longer-term and sustainable demand sources. We also need to know that deleveraging in the private sector has completed its course. People need to feel comfortable to once again to engage in consumption and investment. Furthermore, the recovery is no longer just about the financial sector. It is about the real economy, in particular wages and employment. Until those recover, we can only have tepid growth, but not the level of growth necessary to turn the economy around. Finally, El-Erian mentions how the helium in the growth balloon is being driven mainly by public debt. For the balloon and growth to stay afloat, you need the private sector to kick-in and take over, as well as have the public sector begin dealing with its debt issues. Simple, to the point common sense. Good stuff as always.


Source: CNBC Video

As a follow-up to yesterday's post, many of the hedge funds that are being forced to liquidate positions due to redemptions and deleveraging are seeing an opportunity to take advantage of the mass selling (see Financial Times article). Hedge funds will often be holding many of the same securities, either due to using similar strategies, or simply from chasing the same hot securities. As hedge funds begin unloading these positions, selling pressure will naturally cause lower prices and additional selling in a kind of longer-term reverse short squeeze as the number of redemption notices increases. In a effort to profit from the selling, many of the same funds that are being forced to liquidate are now shorting other securities they don't currently own, but believe other funds are being forced to sell. This cannibalistic activity has been especially troublesome to some of the more popular and well known funds, such as at Ospraie, whose positions are more well-known than small, less capitalized funds. The larger funds are also natural targets given that it often takes a while for them to fully unwind their positions, providing better shorting opportunities. With the TARP bailout bill signed into law, and any benefits of the bill potentially priced into the market, we may be in store for more selling until the prey stop being preyed upon.