(Reuters) - U.S. equities will not revisit the lows hit in March 2020, but the next big correction in stock markets could be triggered by corporate defaults, Mohamed El-Erian, chief economic adviser at Allianz SE ALVG.DE, said on Tuesday.
“I do not expect U.S. equities to revisit the March lows,” El-Erian told the Reuters Global Markets Forum chat room.
“I suspect the next big correction will likely be one triggered by corporate defaults and other capital impairment events that central banks cannot shield against,” he said.
The S&P 500 .SPX index bottomed at an intraday trough of 2,191.86 on March 23 after tumbling from February's all-time high as the spread of coronavirus shut down economies around the world. It has rallied back to within 3% of the record.
El-Erian said he expected the lowest tiers of the capital structure to be most at risk, including “CCC-rated high yield corporate bonds and the like, as well as their equities, also some emerging markets.”
Asked about his positioning ahead of the U.S. presidential election on Nov. 3, El-Erian said he had become defensive ahead of the rally from the March lows.
“I have gotten more defensive in my positioning and, as it turns out, prematurely,” he said.
GRAPHIC: U.S. Fed balance sheet and government bond yields
The one-time PIMCO chief executive said the entire U.S. yield curve <0#USBMK=> could sink below 1% in nominal terms, if “the U.S. is unable to re-initiate a country-wide process of healthy re-openings during this period of living with COVID-19.”
GRAPHIC: Year to date performance of iShares iBoxx Dollar IG Corp Bond ETF & SPDR Bloomberg Barclays HY Bond ETF
U.S. corporate junk bonds JNK.N have broadly provided holders with negative returns this year, despite a wave of central bank liquidity, which has supported corporate investment grade bond LQD.P prices, lifting them from their March lows.
El-Erian said it was unlikely the Federal Reserve would take policy rates into negative territory. “Having said that, I did not expect them to be buying high yield bonds.”
“The sequence is likely to be stronger forward guidance and more QE (quantitative easing), with the related adoption of a more symmetrical inflation target,” El-Erian said, adding the Fed will stay near zero for “a long time!”
Reporting by Divya Chowdhury in Mumbai and Aaron Saldanha in Bengaluru; Editing by Alden Bentley and Sonya Hepinstall
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