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El-Erian Says S&P 500's Plunge May Worsen

Date: Friday, May 21, 2010
Author: Bloomberg

The Standard & Poor’s 500 Index’s 12 percent decline from April’s high may worsen amid concern that Europe’s debt crisis will derail global growth, said Mohamed A. El-Erian, chief executive officer of Pacific Investment Management Co.

“This is not a typical retracement,” El-Erian, 51, whose firm runs the world’s biggest bond fund, wrote in an e-mail to Bloomberg News. “We are in uncharted waters on account of several issues, including what is going on in Europe and other important structural regime changes. In economic terms, European developments are unambiguously bad for global growth.”

Global stocks plunged today after U.S. jobless claims unexpectedly increased and Europe’s debt crisis deepened. The S&P 500, which closed at 1,071.59, has slumped more than 10 percent, the level at which a decline is usually considered a correction, from a 19-month high on April 23. The Stoxx Europe 600 Index sank 2.2 percent, while the euro rallied 0.7 percent to $1.2502 after earlier flirting with a four-year low. Ten-year Treasury yields sank to the lowest of the year, down 15 basis points at 3.22 percent.

European stocks retreated as uncoordinated attempts by policy makers to resolve the region’s debt crisis unnerved investors. Euro-area finance chiefs will meet in Brussels tomorrow to hammer out details of the emergency lending mechanism in a rescue package for debt-burdened governments. The action is aimed at stabilizing financial markets after Greece’s fiscal crisis spread to Portugal and Spain, driving up bond yields and threatening global growth.

‘Risk Aversion’

“This will amplify the impact of higher global risk aversion,” El-Erian wrote. “Some areas -- like the U.S. Treasury bond market -- will also feel the impact of capital inflows on account of flight-to-quality. After over-emphasizing the cyclical tailwinds, markets around the world are now pricing in the structural headwinds, doing so in a rather volatile fashion,” El-Erian wrote.

The benchmark indexes for U.S. and European stock options jumped to the highest levels in more than a year. The VStoxx Index, which measures the cost of protecting against declines in the Euro Stoxx 50 Index, rose 11 percent to 49.87, its highest close since February 2009. The VIX, as the Chicago Board Options Exchange Volatility Index is known, climbed 30 percent to 45.79, the highest level since March 2009.

El-Erian has forecast an extended period of below-average economic growth, increased regulation and lower consumption in what Pimco, which manages more than $1 trillion from Newport Beach, California, has called the “new normal.” The U.S. economy faces a “protracted post-crisis resetting” as high unemployment persists, he wrote in a Bloomberg News column in February.

Investors have wrongly priced in an “orderly” withdrawal of stimulus measures, a rebound in bank lending and coordinated government policy to restore growth, El-Erian wrote. That means Wall Street projections for gains in 2010 may prove incorrect and prices will slump, he said.