Tepid Economy at Heart of Global Market Volatility

At a cabinet meeting on Wednesday, President Obama said the debt deal had averted "a massive blow" to the economy, but it wound up being another rocky day for global markets. Jeffrey Brown discusses the latest on the markets and the economy with Liz Ann Sonders of Charles Schwab & Co. and PIMCO's Mohamed El-Erian.

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    It was another rocky day on the markets, with a fearful beginning, but a more positive end.

    The Dow Jones industrial average was down more than 160 points this morning. But, for the day, it gained more than 29 points to close at 11,896. The Nasdaq rose just under 24 points to close at 2,693. The S&P 500 also rose slightly, avoiding what would have been its longest losing streak since the peak of the financial crisis in October 2008.

    At a Cabinet meeting this afternoon, President Obama said the debt deal had averted a massive blow to the economy, but there were some lasting effects.


    Unfortunately, the debt ceiling crisis over the last month, I think, has had an unnecessary negative impact on the economy here, as well.

    So I'm meeting with my Cabinet here to make sure that, even as they have been throughout these last several weeks, they are redoubling their efforts to focus on what matters most to the American people.


    Earlier, White House spokesman Jay Carney said the president doesn't believe there is a threat of a double-dip recession.

    Wall Street's sharp drops yesterday were felt worldwide overnight and into this morning. Asian stocks fell amid increasing pessimism over weak economic prospects in the U.S. European stocks also fared poorly amid continuing debt problems in a number of nations, including Italy and Spain, where bond yields surged to 14-year highs.

    Joining us now to discuss the latest on the markets and the economy are Liz Ann Sonders, senior vice president and chief investment strategist for Charles Schwab and company, and Mohamed El-Erian, CEO of Pimco, a global investment management firm and the world's largest bond fund.

    Liz Ann Sonders, I will start with you.

    What happened starting about a week ago to start this market, all the jitters?

  • LIZ ANN SONDERS, Charles Schwab:

    Well, I think the market's had its eyes on several things.

    Clearly, the debt ceiling debates was a big factor, and I think that weakened some confidence. But, in addition, last week, we got the beginning of what was a string of fairly weak economic readings, the first primary one being the GDP, gross domestic product, report for the second quarter, which was not only weaker than expected at only 1.3 percent, but the prior quarter was revised down quite a bit to barely into growth territory, only 0.4 percent.

    And they not only did that, but they went back and they revised the entire recession's period, such that we now know that the decline in the economy during the recession was a little bit more than five percent, as opposed to only a little bit more than four percent.

    And, finally, what that actually means is, prior to those revisions, the economy looked to already be in expansion, meaning that the economy had grown to — back to its 2007 highs. With those downward revisions, we're back down below the 2007 highs, which means we're still only in recovery.

    And then we have had some additional weak economic news, and I think the market had a tough time with that.


    Well, Mr. El-Erian, what would you add to that? What triggers do you see here?


    You know, Jeff, all year — so, it's not just this week — it's been all year — the market has been torn, torn between worrisome top-down news and good bottom-up.

    The best way to think about this, Jeff, is suppose you are considering a good and improving house in a bad and deteriorating neighborhood. How would you feel? You would feel torn. So, on the one hand, the markets like the fact that companies are doing well, they have strong balance sheets, lots of cash, and they have tapped into growth in the emerging world.

    On the other hand, as Liz Ann said, the economy is weakening. Policy flexibility is limited. The politics is not just divided government. It is, as President Obama said, dysfunctional government. And then there's concerns in Europe.

    So you're seeing this amazing tug-of-war, and the last eight days or so, it has been the bad neighborhood that has dominated the good house.


    Now, Liz Ann Sonders, what explains what happened today then? Is it — I mean, I know you can never look at one day and tell all that much. Is it a pause?




    What — what goes on, on a particular day?


    Well, you never know what goes on, on a particular day. And I think there's multiple dynamics.

    Probably the best explanation was that some of the selling just simply got exhausted. We hit some technical levels in the market that brought some buyers in. We hit sentiment conditions. Sentiment, by the way, works in a contrarian way. So particularly when individual investors become very, very pessimistic, that usually sets up an opportunity for the market to rally a little bit. So that may have happened.

    We may have hit a little bit of a short-term exhaustion point. But we had an intraday rally. We closed up. That was a nice thing. I don't know that that necessarily means we're off to the races here. I think there's still a lot that the market has to digest.


    Now, Mohamed El-Erian, you mentioned the government situation. Is there still, do you think, the possibility of a credit downgrade, even after the debt deal? Where are we on that and what impact — how does that impact markets?


    The possibility is there, and it's really S&P, one of the two rating agencies.

    So, the other one, Moody's, came out last night and said, we're going to keep the U.S. at AAA, but we're putting the outlook on a — on negative, which means that we're worried that it's deteriorating over time. S&P has been much stronger.

    Back on July 14, it put the U.S. outlook on negative watch, which means a presumption that you will downgrade unless you get policy reaction. It's a question mark as to whether there's been enough out of Washington, whether this debt ceiling is going to satisfy S&P or not. And we're going to have to wait.

    If we do get a downgrade, I suspect that the markets will not take it well.


    Liz Ann Sonders, what would you add to that? And, also, just — you mentioned Europe a little earlier. How much are — those problems have been with us a good while as well. How much does that continue, though, to weigh on our markets?


    I think it has, in fact. Unfortunately, some of the problems have now moved out of what they call the periphery, which would be some of the smaller countries like Greece, and now the latest two countries that are really feeling the pressure of this are Italy and Spain.

    And that's a much different set of problems obviously in terms of the size of the problem, the integration into the European and global banking systems. So, that kind of re-erupted. And I think the market was contending with that.

    Back to what Mohamed was talking about on the ratings downgrades, I think what is still uncertain are a couple of things. One, treasury bills are used as collateral, particularly with lending from bank to bank. And if the ratings agencies, particularly S&P, downgrades treasuries, then suddenly that collateral is worthless, so the cost of borrowing goes up.

    And if yields go up or rates go up, then the cost of borrowing across the board goes up. There is also a question about whether there will be any forced selling. A lot of funds have mandate to hold AAA securities. Whether they can change those covenants or not is yet to be seen, but there may be some forced selling, which would put some additional pressure on yields, too.

    And there's other things, but there are some unanswered questions that I think market is trying to grapple with in the event of a downgrade.


    Well, when you look forward, Mr. Mohamed El-Erian — I think it was your colleague at Pimco, Bill Gross, today referred to the economy as in stall speed. It might have been you. It might have been him. I read it some — read it coming out of the company.

    But what does that mean when you're looking at the prospects for growth and for your company? As a major player, people watch how you're betting.


    So, Jeff, that is a key issue as to the — can we survive in stall speed, we being the American economy? And it's also true for Europe.

    So, the concept of stall speed, think of a plane. The plane has to move forward at a certain speed. Otherwise, it comes down. Our economy has to move forward. We are still over-levered. There's still too much debt in the system. We need to grow out of our debt problems.

    So, if we get stuck with growth of about two percent, that's simply not enough. So we risk tipping into a worse equilibrium, as we call it here. So this concept of stall speed is very, very important for a de-levering economy. And that's true for the U.S. and especially true for Europe.

    And so what it means, it means that investors should be very careful. They should recognize that the rules of the game are changing. The fact that we're talking about the possibility of the U.S. being downgraded would have been unthinkable a year ago, two years ago.

    So it's very important to adapt the intellectual framework to be agile and to understand that this is happening in a global environment and that the opportunities are global. So, be it Pimco, be it Schwab, be it any firm, I suspect you will find that firms are becoming more global and they're looking for opportunities much wider than just the local market, and they're managing risk also in such a fashion.


    All right. Well, we will end on that interesting, provocative note.

    Mohamed El-Erian and Liz Ann Sonders, thanks very much.


    Thanks, Jeff.