From an asset-allocation perspective, this involves a call on the success of two more regime transitions that are also ongoing: in global growth dynamics and trade interactions, and in the rebalancing of macro-policy in systemically important countries.
As I have argued, the world economy needs much stronger pro-growth leadership after benefiting from the fortunate coincidence of four largely unconnected drivers of economic expansion: policies in the U.S., natural healing in Europe, a soft landing in China, and rebounds from shocks in Brazil (political), India (demonetization) and Russia (commodities). For example, the U.S. needs to build on positive developments by supplementing recent measures with a productivity-enhancing infrastructure program. Europe should do more to implement structural reforms, rebalance its fiscal-monetary mix and strengthen the regional economic and financial architecture.
Investors' assessments of the probability of such changes speak directly to their view on how, where and when the gap between market prices and fundamentals will be closed. The orderly convergence of fundamentals to market prices, thereby validating them, is the best outcome. And that is not the only big call investors face. In considering allocations to specific sectors and securities, they also need to take a position on what are likely to be a handful of defining phenomena over the next few years -- for example, in tech, regulation, geopolitics and the alignment of the global economy.
Putting aside geopolitical risk, my evaluation of these issues points to three main takeaways that feed into investors’ assessment of how much risk they should take and where they should take it.
-There is a 65/35 probability of a successful navigation of the three major regime changes in markets, policy and growth. These odds reflect the view that the current phase of tit-for-tat tariffs by China and the U.S. is not the prelude to a full trade war but, instead, part of a negotiating process toward trade that is fairer and more free.
-It will be hard for Big Tech to avoid some regulatory backlash. The ongoing repricing of the sector will have a differentiated effect, as those perceived widely to be broad suppliers of personal data (such as Facebook) are potentially more affected than those believed to be indirect suppliers (such as Amazon and Netflix).
-With an increasing number of sectors being disrupted -- specifically, by the accelerating advances in artificial intelligence, big data and mobility -- the relative performance of companies in the bigger corporate universe will be substantially influenced by how well they harvest the power of machine learning, data processing and updated consumer interfaces.
Here is the silver lining of the current bout of greater volatility for investors able and willing to respond: Days of particularly pronounced market moves, both up and down, tend to be associated with high co-movements in sectors and individual companies. As such, they also provide attractive opportunities to reposition for longer-term themes.
Mohamed A. El-Erian is a Bloomberg View columnist. He is the chief economic adviser at Allianz SE and chairman of the President’s Global Development Council, and he was chief executive and co-chief investment officer of Pimco.
This column was provided by Bloomberg News.