MacroView: El-Erian & The Two Primary Risks In 2021

In 2019, I discussed the disconnect between the markets and the economy. After years of Central Bank interventions, stock markets have soared to record highs, while economic growth has remained weak. Mohamed El-Erian recently discussed the two primary risks heading into 2021.

El-Erian began his article by asking the most relevant question.

“What, if anything, will happen to the great disconnect between Wall Street and Main Street?”

The Great Disconnect

Currently, Wall Street analysts are projecting record stock markets in 2021, with stock prices rising another 10% and earnings surging toward record levels.

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El-Erian Primary Risks, #MacroView: El-Erian & The Two Primary Risks In 2021

Main Street, however, believes the economy is heading in the wrong direction.

El-Erian Primary Risks, #MacroView: El-Erian & The Two Primary Risks In 2021

Such is the question we have discussed previously, given that the “stock market is ultimately a reflection of the economy.”

The detachment of the stock market from underlying profitability guarantees poor future outcomes for investors. But, as has always been the case, the markets can certainly seem to ‘remain irrational longer than logic would predict.’

However, such detachments never last indefinitely.

The stock market is NOT the economy. But the economy is a reflection of the very thing that supports higher asset prices – corporate profits.”

Importantly, this detachment is now a key consideration for policy-makers and investors as we head into 2021.

 

A Remarkable Gap

“Throughout this pandemic year, we have experienced a further sharp widening of an already remarkable gap between financial markets and the economy. A rapid recovery in asset prices from the March 23 lows took major US indices to record levels, even before the recent good news on Covid-19 vaccines. Combined with even more accommodative central bank policies, this enabled record debt issuance at historically low levels of compensation for creditors.” – El-Erian

There is no doubt that corporations did indeed take the Federal Reserve up on both near-zero interest rates and a guaranteed buyer of bond issuance. In 2020, investment-grade bond issuance hit a record with total non-financial debt soaring to all-time highs. Such was occurring at a time when revenues and profits were plunging.

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El-Erian Primary Risks, #MacroView: El-Erian & The Two Primary Risks In 2021

That data includes the record levels of “junk bond” issuance in the market.

“Issuance in 2020 through August was $291.9 billion, up 71% year over year. Credit strategists at BofA Global Research now project a full-year primary volume of $375 billion. Such would shatter the current record total of $344.8 billion in 2012, according to LCD.”

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El-Erian Primary Risks, #MacroView: El-Erian & The Two Primary Risks In 2021

Of course, the issue is that over the next few years, there is a tremendous amount of debt coming due. If rates risk markedly, or if the market demands payment for the relative risk, refinancing could become problematic.

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