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

The gap in yield between the 10-year TIP (Treasury inflation-protected security) and the regular 10-year Treasury surpassed two percentage points, as investors begin to price in expectations of inflation (see WSJ article). This comes on the day that Federal Reserve Chairman Bernanke warns of how longer-term deficits are threatening the financial stability of the U.S., as yields on longer-term Treasuries and fixed-rate mortgages rise (see Bloomberg article).

U.S. 10-Year Treasury
Source: BigCharts.com

iShares Barclays TIPS Bond Fund
Source: BigCharts.com

In an effort to take advantage of increased investor interest in Treasuries, Pimco (Pacific Investment Management Company) is launching its first ETF, the Pimco 1-3 Year U.S. Treasury Index Fund (ticker TUZ, see MarketWatch article). The current Pimco ETF was developed for investors with a focus on maintaining stable principle with little or no credit risk. The new ETF is one of approximately 65 fixed-income exchange traded funds listed in the U.S., a small number compared to the much larger equity ETF universe. In addition to the new ETF, Pimco filed prospectuses with the SEC for six additional ETFs. Three of the new ETF will cover the 3-7 year, 7-15 year, and 15+ year Treasuries. The remaining three will be tied to the U.S. TIPS, including a general TIPS Index Fund, a short maturity U.S. TIPS Index Fund, and a long maturity TIPS Index Fund. The Pimco TIPS funds are expected to compete with the iShares Barclays TIPS Bond Fund (ticker TIP, see chart above). Such products will give investors betting on hyperinflation, such as Nassim Taleb (see previous post), a new vehicle for placing their bets.

Pimco's is working to raise money for a $5 billion fund to purchase tranches of depressed mortgage-backed debt (see London Telegraph Telegraph article and Bloomberg Bloomberg article). Pimco managers are meeting investors to gain commitments for the new fund, called the Distressed Senior Credit Opportunities Fund (already dubbed Disco). The fund will invest in senior and super-senior securities backed by commercial and residential mortgages. Of interest is that while the fund will look for securities backed by traditional home equity, credit cards, and auto loans, the focus of the fund will be more international. Given the senior nature of the debt, the fund will be less risky than some other debt funds. Subordinated debt, selling at even more distressed levels, is still raising concerns. The current move appears more opportunistic than an indication that the credit issues are behind us. As seen recently with other similar investments by John Paulson and Goldman Sachs, those with the capital can often name their price and define their terms. Just a new spin on the golden rule: "Those with the gold make the rules."