Mohamed El-Erian's Guide to Global Investing

Mohamed El-Erian

In today's markets, investors must navigate the simultaneous deleveraging of three distinct, though inter-related, balance sheets: those of the financial system, the housing sector and the consumer. The challenge goes well beyond just side-stepping the damage associated with the forced shrinkage of any one of these balance sheets; investors must also steer around the inevitably messy and unpredictable feedback loops resulting from the interaction of the three balance sheets.

For investors that hold long positions in any risk assets (such as equities and corporate bonds), the impact has been similar to that felt when oxygen is sucked out of a room: Everyone feels dazed and struggles to catch his or her breath, and the weak suffer more than the strong.

In other words, the process creates broad-based risks that, initially, are felt by all. Investors experience highly correlated declines across a number of domestic and international markets -- with the weakest segments subject to major turmoil. But the process also gives rise to isolated pockets of opportunities that can be highly rewarding.

With time, the deleveraging dynamics will dissipate -- either because they exhaust themselves, or because a circuit breaker is triggered that allows for an earlier and more orderly market bottom to form. At that stage, the isolated pockets of opportunities develop into broad-based ones that provide sustainable high returns for investors that understand and are able to exploit the new situation.

When Markets Collide seeks to offer investors tools to analyze the ongoing transformation of the global financial landscape. It is a book for those who believe that today's large market dislocations speak to the emergence of new return opportunities that, importantly, come wrapped in a new configuration of risks that must be managed proactively.

The book starts with an important historical perspective that highlights the extent to which markets signaled the initiation of key structural transformations through the simultaneous emergence of inconsistencies and pricing aberrations in key market and economic relationships; and, regrettably, the degree to which too many investors (and policymakers) dismissed these signals as constituting nothing more than normal "market noise" that requires no major change in mindset and strategies, and therefore, no bold response.

The failure to treat the noise as signals has resulted in the series of "market accidents" and "policy mistakes" that have been with us since the middle of last year. Too many balance sheets and market players were caught offside, with too much leverage and too little risk management. Market infrastructures were not adequately set up to deal with the proliferation of new instruments. And policymakers took too much time to recognize the problems. When they acted, they did so using blunt instruments and outdated information.

As a result, the unthinkable became thinkable. Well regarded iconic institutions tripped up and, in the case of Bear Stearns, ceased to exist. Long lines formed outside banks in the two most sophisticated financial centers in the world -- the U.S. and the U.K.-- as depositors rushed to pull their money from failing banks (IndyMac and Northern Rock in particular). A seemingly contained dislocation in the subprime segments of the mortgage market morphed into a generalized credit crunch that risks pulling the rug from underneath global economic growth.

Meanwhile, policy makers have been thrown into "crisis management" mode. By necessity, they are implementing consequential policy measures on the fly and piecemeal, rather than in a comprehensive and planned manner. And politicians have started the process of trying to identify and hold accountable those that they perceive as responsible for "losing" a global financial system that has served us all so well for a large number of years.

When Markets Collide suggests that the issues facing the system are not subject to a simple "reset button." Indeed, rather than settling down quickly through some conventional "reversion to the mean," the dislocations are creating new realities on the ground that have profound economic and institutional implications for investors.

By delving deep into the fundamental forces driving today's structural transformation, When Markets Collide suggests that every level of the economic and financial chain faces some consequential retooling challenge: individual investors, financial firms, governments, and multilateral mechanisms. It provides insights as to the nature of the retooling challenges, and components of the appropriate response.

In the case of investors, the focus is on such issues as the right asset allocation going forward, the appropriate choice of investment vehicles to implement this allocation, and the components of responsive risk management.

When Markets Collide concludes by arguing that it is both urgent and important for investors to act of each of these issues. Indeed, the major question is not whether investors will end up by doing so. They will. The real question is whether they will do so proactively, or will an inherently disorderly process be forced on them by changing market realities.

Mohamed El-Erian on TheStreet.com TV: Colliding Markets, Smashing Profits

To watch the video, click the player below:

To hear more from El-Erian on TheStreet.com TV, don't miss PIMCO Chief Grades Bernanke, Paulson, where he assesses Federal Reserve Chairman Ben Bernanke's performance during the credit crisis and explains why Alan Greenspan is not to blame for the financial meltdown.

1 What would best describe your stance heading into the coming week of trading? Bullish Bearish Neutral 2 Which of these sectors do you think is set to move up in the coming week? --Choose One--Aerospace and DefenseAirlinesAutomobilesBeverages and Food ProductsBiotechnologyCommercial BanksComputers and PeripheralsConsumer NondurablesEnergy Equipment & ServicesHMOs and HospitalsHomebuildingInsuranceIntegrated OilInternet, Software ServicesInvestment Bankers and BrokersMediaMultiline RetailPharmaceuticalsPrecious MetalsSemis, Semi EquipmentTelecom EquipmentTobacco and AlcoholWireless CommunicationsUtilities 3 Which of these sectors do you think is set to move down in the coming week? --Choose One--Aerospace and DefenseAirlinesAutomobilesBeverages and Food ProductsBiotechnologyCommercial BanksComputers and PeripheralsConsumer NondurablesEnergy Equipment & ServicesHMOs and HospitalsHomebuildingInsuranceIntegrated OilInternet, Software ServicesInvestment Bankers and BrokersMediaMultiline RetailPharmaceuticalsPrecious MetalsSemis, Semi EquipmentTelecom EquipmentTobacco and AlcoholWireless CommunicationsUtilities View the results without voting

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