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Stocks will drop sharply, Pimco’s CEO predicts

Associated Press / December 28, 2009

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NEW YORK - Homes are selling at their fastest clip in nearly three years, the unemployment rate is falling, and stocks are up 66 percent since their March lows - the best performance since the 1930s. What’s not to like?

Plenty, says Mohamed El-Erian, chief executive of the giant bond manager Pimco. The recovery may be gaining steam but is no different than a kid who eats too much candy, he says. “We’re on a sugar high,’’ El-Erian says. “It feels good for a while but is unsustainable.’’ His point: This burst of economic activity fed by government spending and near-zero interest rates will soon peter out.

El-Erian oversees nearly $1 trillion in assets. What he’s saying:

■Stocks will drop 10 percent in the space of three or four weeks, though he’s not predicting when.

■The unemployment rate will be hovering above 8 percent a year from now.

■US gross domestic product will grow at an average of 2 percent or so for years - a third slower than we’re used to.

El-Erian says people are fooling themselves if they think all the bullish data of late mean a strong recovery is in the offing. So he’s buying Treasurys and selling riskier stuff. His bet: Investors will get scared again and want US-guaranteed debt.

Investors betting on stocks or high-yield bonds are apt to be disappointed, he says.

Markets for those securities are rallying not because people like them but because they hate the puny yields of safer investments like money markets and feel they have no choice but to buy, he says. That makes the bull market as likely to last as a forced marriage, he quips.

The danger: If stock and junk bond prices start falling, lots of investors are likely to bail, feeding the drop.

Of course, there are true believers in the bull who are not buying El-Erian’s line.

James Paulsen, chief strategist at Wells Capital Management in Minneapolis, with $355 billion under management, has been pounding the table for months to buy stocks. Just as in the early 1980s, the recovery will take the form of a “V,’’ he says. The reason: Companies have cut inventories and payrolls to the bone, so just a little revenue growth could yield a bumper crop of profits.

El-Erian says many of the bulls don’t appreciate just how much the government props still under the economy are masking its weakness. Instead of focusing on the fundamentals today, he says, they’re looking to the past, expecting a quick economic rebound because that’s what’s happened before.

We’re trained to think the “farther you fall, the higher you’ll bounce back,’’ El-Erian says. “We’re hostage to the V.’’