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Stocks Are Getting Some Love, But Can It Last?

Mohamed A. El-Erian

(Bloomberg Opinion) -- As U.S. stocks continue to build on an exceptionally long rally and outperform their international peers, technical factors are positioned to buoy what appears to be a favorable short-term outlook. They can do little, however, to lift broader uncertainty, posing a challenge for long-term investors on how to position their portfolios.

Stocks have responded well to sunnier economic and policy news. Global data point to a possible bottoming out of the recent worldwide growth slowdown that involves 90% of countries, according to the International Monetary Fund. China-U.S. trade tensions, seen by many not only as a notable restraint on growth but also a significant risk, continue to de-escalate, though haphazardly. And, most significantly, the two most systemically important central banks — the European Central Bank and the Federal Reserve — have resumed major injections of liquidity through large bond purchases in the marketplace, massively amplifying the effect of a new round of rate-cutting elsewhere. With that, equity markets, along with the bond market, have taken comfort with the notion that the Fed may be on hold for now after three cuts this year.

With these short-term headwinds diminishing, markets are poised to benefit from greater engagement by investors that have yet to fully embrace what many have consistently called a mis-loved rally.  After all, many more-conventional institutional and retail money investors have remained relatively underinvested, opening the window for a technically driven leg up that propels U.S. indexes to even more records.

But these favorable short-term conditions have done little to allay longer-term uncertainties, at least for now.

Global economic prospects remain unsettled, particularly in Europe, where the prospects for meaningful pro-growth fiscal and structural reform policies are elusive. Some economists are even worried that, judging from the weekly jobless claims data, the U.S. labor market may be losing strength. Already, some forward-looking indicators of gross domestic product growth have been revised downward.

Among all this, Chinese and U.S. negotiators are taking their time to agree on what, at best, would be a “phase one” deal — suggesting that the recent de-escalation in tension could well prove short-lived given the thorny longstanding issues that remain unresolved. Additionally, the stepped-up central bank liquidity injections are taking place amid growing concerns about unintended consequences and collateral damage, especially those associated with prolonged reliance on unconventional monetary measures (including the growing risk of financial instability) and visible divisions within the central banking community. And let’s not forget national politics, where the shift to more inward-looking and less corporate-friendly policies continues to gain traction, suggesting that a pause — if not an outright reversal — in economic and financial globalization is far from over.

With such a contrast between short- and longer-term prospects for markets, investors would be well advised to keep a stake in the rally for now while at the same time moving up in quality to better navigate possible future setbacks. It’s a strategy that requires a lot more attention not only to the implied equity and credit risks inherent in current broad public market exposures but also those relating to liquidity and leverage. And it’s a strategy that, despite a considerable valuation gap, would continue to suggest fighting the inclination to swap out of U.S. markets in favor of the significantly underperforming international ones.

To contact the author of this story: Mohamed A. El-Erian at melerian@bloomberg.net

To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. He is president-elect of Queens' College, Cambridge, senior adviser at Gramercy and professor of practice at Wharton. His books include "The Only Game in Town" and "When Markets Collide."

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