Economist Mohamed El-Erian warns more wild volatility in stocks is likely, and sets out two overlooked factors driving the swings

• Mohamed El Erian said the dizzying volatility seen in stocks in January is likely to stick around for a while.
• The economist noted two factors accentuating the swings: patchy liquidity and the rising role of ETFs.

The wild volatility in stocks seen in recent weeks is not a thing of the past, top economist Mohamed El-Erian has warned.

"In addition to the sharp drop in markets in January, the dizzying intraday volatility added uncertainty and contributed to an unsettled feeling about the future, and not just because of the marked change in the policy stance of the Federal Reserve," he wrote in a Bloomberg column.

"The volatility is likely to stick around, at least for a while."

In January, US stock markets saw sharp intraday reversals, and on a single day the Dow Jones Industrial Average swung more than 1,000 points. The S&P 500 and the tech-heavy Nasdaq notched their worst month since March 2020, when the pandemic hit.

The sell-off came as the Federal Reserve signaled it was ready to raise interest rates several times in 2022, and to pull back on economic support, in a bid to tame hot-running inflation. Investors closely watched fresh data that might influence the Fed's decision making.

"It should come as no surprise that markets have become so sensitive to macroeconomic data releases, be they a hot labor market and higher-than-expected consumer price increases or lower-than-expected employment costs," El-Erian said.

But El-Erian, who is chief economic advisor to PIMCO parent Allianz, said there were factors being overlooked by investors.

"While this is the main factor driving the current bout of volatility, it is being accentuated by two factors that attract too little attention, even though they have become a structural feature of today's markets," he said.

"The first is patchy liquidity, including for even the most widely held stocks."

"The second structural factor speaks to the growing role and influence of exchange-traded funds," he added.

The liquidity issue hampers the system's ability to absorb risk, which feeds into volatility, El-Erian said. It reflects an imbalance between an increase in end-users and smaller balance sheets at intermediaries.

As for ETFs, he noted that they made up 40% of the record level of trading volume last Monday — an apparently high level of liquidity that contrasts with the illiquidity of the individual stocks in the funds — which helped intensify the rush to sell.

Most analysts believe market volatility will continue to grip markets, but they vary on how long it might last and how damaging it could be. UBS believes that for longer-term investors, it could be beneficial, as it will take some of the air out of the more speculative corners of the market.

El-Erian said investors have become used to high liquidity that has led to markets that move in a single direction: up. But it's now not clear how long certain notions driving trade — There Is No Alternative (TINA), Fear Of Missing Out (FOMO) and Buy The Dip — will last.

"After such a dizzying January in markets, many of us are hoping for a quick return to the 2021 days of low volatility. Unfortunately, this is likely to take a while, risking both market and economic damage," he said.