After suffering the worst first-half of the year since 1970, the S&P 500 finished its best month in two years in July, but top economist Mohamed El-Erian isn’t calling a bottom just yet, suggesting that the recent rally is at odds with the economic data.
“July was an illustration of the adage that ‘the market is not the economy’,” El-Erian said in an op-ed for Bloomberg on Monday. Despite a 12% gain for the S&P 500 last month, El-Erian emphasized that the economy has not shown signs of improvement.
Consumer Price Index data clocked in at a 41-year record of 9.1% in June, leading the Federal Reserve to issue another aggressive rate hike last week as officials scramble to put out the inflation fire. Gross domestic product also declined for the second consecutive quarter, putting the US into a technical recession, even if it hasn’t been officially called yet by the National Bureau of Economic Research.
The poor outlook extends beyond the US. With energy supply shortages stemming from Russian sanctions and rising inflation worldwide, the International Monetary Fund said the outlook on the global economy looked “gloomy and more uncertain” – a warning El-Erian says investors should take seriously even as markets rally.
“Having worked at the [IMF] for 15 years earlier in my career, I can assure you that officials there do not use the words such as ‘gloomy’ lightly,” El-Erian said.
El-rian said the rally in stocks last week stemmed from an unscripted comment Fed Chair Jerome Powell gave at the press conference following the latest rate decision. Although the central bank acknowledged they were still “highly attentive” to inflation, Powell said he believed inflation had reached the neutral level. That’s an inflation level where monetary policy is neither expansionary or restrictive — in other words, suggesting the US’s chief central banker believes prices have likely peaked.
El-Erian said that probably spurred investors into thinking the Fed would soon ease up on tightening economic conditions, bringing markets closer to what they enjoyed during the pandemic era of easy money and ultra-low interest rates.
“It should come as no surprise that markets are so sensitive to any hint of a return to the uber-stimulative, liquidity-abundant policy regime. Yet high and potentially sticky core inflation greatly limits the Fed’s ability to pivot back to such a regime any time soon,” El-Erian said.
Others have slammed Powell for making the comment, including former Treasury Secretary Larry Summers, calling Powell’s remark “analytically indefensible” and “inexplicable” in an interview with Bloomberg.
El-Erian has been a loud critic of the Fed for not taking the reins on inflation soon enough, and has previously proposed it would be hard for the central bank to steer the US economy into a soft landing. He added that the future of the market largely depends on how sticky inflation is and how severe a potential recession might be.