- Investors should avoid "distorted markets that have created a lot of damage," Mohamed El-Erian said.
- The economist recommended holding cash and short-term bonds.
Stock and bond markets appear "distorted," meaning it's high time for investors to tweak their portfolios, according to Mohamed El-Erian.
El-Erian said Friday, against a backdrop of falling stock and bond prices in recent weeks, that investors should hold cash and short-term, fixed-income assets.
"We need to get out of these distorted markets that have created a lot of damage," Allianz's chief economic advisor told CNBC at the Ambrosetti Forum in Italy. "We are repricing — I don't think we're quite there yet, but we're certainly getting there."
The benchmark S&P 500 has tumbled 6.5% since Fed Chair Jerome Powell's Jackson Hole speech on August 25, while global bonds slipped into their first bear market in three decades on Friday.
El-Erian said the simultaneous correction — which typically only happens once every 50 years, according to the Swiss bank Mirabaud — means that investors need to pivot to risk-off assets.
"There was a time when all asset prices went up — stocks and bonds — and we forgot about correlations," he said, referring to the cross-asset rally that took place during and immediately after the coronavirus pandemic. "Why care about correlations when you're being paid for holding both risk assets and risk-mitigating assets? It's a lovely world."
"But the first half taught us, and what we have again learned since the middle of August, is that [stocks and bonds] can both go down at the same time," El-Erian added. "In a world like that, you have to look at short-dated fixed income, and you have to look at cash as an alternative."
El-Erian's embrace of cash is somewhat contrarian, as historically high inflation is eroding the value of currencies. Billionaire investor Ray Dalio has proclaimed "cash is trash" several times in recent years, while Warren Buffett said earlier this year that "inflation swindles the person that keeps their cash under their mattress."
Meanwhile, US 3-month Treasury bills currently offer yields of just 2.84%, lagging considerably behind Consumer Price Index inflation, which hit 8.5% in July.
El-Erian predicted that markets are likely to spend the next few months debating which inflation metric best reflects the health of the US economy. He said that a potential divergence between yearly and monthly inflation prints would likely cause further "dispersion" for stocks and bonds, making risk-mitigating assets more attractive.
"The real issue is -—which inflation rate?" he said. "I don't just mean is it headline, is it core, is it CPI, is it PCE. It's also — is it year-on-year, is it month-on-month?"
"Life is getting complicated because these measures are going to start diverging," El-Erian added. "If we're sitting here in six months' time, we're going to be talking not about common shocks, but about dispersion, among economic performance, among different segments of the market."