Mohamed El-Erian says stocks are vulnerable despite tumbling bond yields, due to 'speculative excess'

• Mohamed El-Erian has said stocks remain vulnerable despite the sharp fall in bond yields.
• He is increasingly concerned about inflation, which he says could force the Fed to quickly wind down support.
• He wrote in the FT that "speculative excess" has been building up, putting stocks at risk of falling.

Markets veteran Mohamed El-Erian has said stocks are vulnerable to falls despite the recent drop in bond yields, as investors may have had "too much of a good thing" and could be rocked when the US Federal Reserve starts to unwind its support.

El-Erian, chief economic advisor to Allianz, wrote in the Financial Times that "speculative excess" had built up and companies had loaded up on unsustainable debt thanks to ultra-loose monetary policy from central banks.

He said that the Fed is behind on inflation, adding that the longer it waits to reduce its support for the economy to cool price rises, the bigger the risk that it will "be forced into slamming the policy brakes on at some point."

El-Erian, who was previously chief executive of investment giant PIMCO, which is part of Allianz, said there was also a risk of widespread "de-grossing." That is where investors cut their positions in risky stocks and government bonds due to rising inflation. El-Erian said this could cause "adverse contagion for a bigger set of financial assets."

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However, El-Erian said the most likely outcome from last Thursday's stocks sell-off was a rebound. He said this would probably be driven by three themes: "TINA, or there is no alternative to stocks with yields so very low; BTD, buy the dip as the liquidity wave continues; and FOMO, fear of missing out on yet another move up in stocks."

Yet he added: "We are moving irresistibly closer to a critical question for the economy and markets, and not just in the US: is there still the possibility of an orderly exit from what has been a remarkably long period of uber-loose monetary policies?"

El-Erian has become more pessimistic about the outlook for markets and the economy in recent months due to what he sees as potentially dangerous inflation.

But other investors remain bullish about US stocks, with many believing that inflationary pressures have peaked.

Fundstrat's Tom Lee told CNBC on Friday the S&P 500 could surge to 4,700 by year-end. He said stronger inflation is likely to send investors towards stocks that stand to do better from a growing economy and rising prices, such as in the energy sector.