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July 18, 2020, 10:11 a.m. EDT

It’s time for investors to stop buying stocks that are ‘stunningly decoupled’ from reality, economist warns

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By Shawn Langlois, MarketWatch


Getty Images
Mohamed El-Erian

‘The investing challenge may well shift in the months ahead from riding an exceptional wave of liquidity, which lifted virtually all asset prices, to steering through a general correction in prices and complex individual nonpayments.’

That’s Mohamed El-Erian, Allianz’s chief economic adviser, talking about what investors should expect going forward, as “the financial stress caused by COVID-19 is far from over.”

El-Erian, the former Pimco CEO, pointed to several “worrying signs,” including a record-breaking pace for corporate bankruptcies, job losses moving from small and medium-size firms to larger ones, and more households falling behind on rents, to name a few.

“Investors are showing insufficient concern. Some continue to expect a sharp, V-shaped recovery in which a vaccine, or a buildup of immunity in the population, allows for a quick resumption of normal economic activity,” he wrote in the Financial Times. “Others are relying on more backstops from governments, central banks and international organisations.”

He explained in the op-ed that investors still have time to prepare for the tough times ahead and follow the lead of Wall Street pros by adjusting their portfolios accordingly.

“Rather than buying assets at valuations stunningly decoupled from underlying corporate and economic fundamentals, investors should think a lot more about the recovery value of their assets,” he said, pointing to a “new generation” of traders pushing stocks relentlessly higher. “The sense that the worst did not come to pass has fed complacency among investors of all stripes.”

While retail investors continue with the risk-on attitude, El-Erian says the smart money has been raising cash in hopes of putting a “dual investment strategy” to work — this includes keeping some powder dry for rock-solid companies to correct to bargain prices as well as being ready to step up with “well-structured rescue financing” when bankrupt companies look to reorganize and recover.

“Liquidity-driven rallies are deceptively attractive and tend to result in excessive risk-taking. This time, retail investors are front and centre,” he wrote, adding that the market’s “next stage” will require “much more careful scrutiny from investors than the past few months have demanded.”

Investors were still in the risk-on frame of mind on Tuesday, with the Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA +0.17% up more than 300 points, while the S&P 500 /zigman2/quotes/210599714/realtime SPX +0.06% and tech-heavy Nasdaq Composite /zigman2/quotes/210598365/realtime COMP -0.87% also ticked higher.

/zigman2/quotes/210598065/realtime
US : Dow Jones Global
27,433.48
+46.50 +0.17%
Volume: 324.93M
Aug. 7, 2020 5:10p
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/zigman2/quotes/210599714/realtime
US : S&P US
3,351.28
+2.12 +0.06%
Volume: 2.28B
Aug. 7, 2020 5:10p
loading...
/zigman2/quotes/210598365/realtime
US : U.S.: Nasdaq
11,010.98
-97.09 -0.87%
Volume: 3.85M
Aug. 7, 2020 5:16p
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Shawn Langlois is an editor and writer for MarketWatch in Los Angeles. Follow him on Twitter @slangwise.

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