'Significant baggage': Mohamed El-Erian outlined for us the challenges facing American exceptionalism in markets and the economy

• Mohamed El-Erian thinks stocks and the economy will be weighed down by "baggage."
• He pointed to a vulnerability in markets created during the era of cheap money.
• US exceptionalism could struggle as the paradigm shifts.

Mohamed El-Erian sees a potentially difficult path ahead for US markets and the economy.

The top economist and former co-CIO at PIMCO said there are challenges facing American exceptionalism — the idea that US markets and the economy will continuously outperform the rest of the world in returns and economic growth.

That's due to a vulnerability that's been lurking in markets in recent years, which spawned during the era of ultra-low interest rates and abundant liquidity, El-Erian told Business Insider this week.

He said investors have been conditioned to buy the dip in markets, a factor that's pushed stocks to record-highs.

Despite unresolved tensions in the Middle East, the S&P 500 closed above 7,200 for the first-ever time on Thursday and ended April with its best monthly performance since 2020.

"An important question going forward is whether this process can continue at current valuations," El-Erian said. "Both the economy and markets carry significant 'baggage' from a period of relatively free and abundant money, driven by overly loose fiscal and monetary policies."

The era of cheap money ended several years ago as the Fed began to raise interest rates and tighten monetary policy to wrestle inflation back down. The central bank is still in easing mode, but concerns about inflation have come back to the forefront as oil prices soar from the Iran war.

El-Erian said he believes there is a "limit" to how far the US can stray from the rest of the world economy, referring to the US's outperformance in terms of economic growth. He pointed to "increasingly challenging geo-economics" as the Iran war enters its third month.

"Having ridden an enormously remunerative wave, it may well be time for investors to focus more on relative positioning rather than on extending absolute risk-taking," he said of markets.

Enthusiasm for stocks is still running hot, but myriad economic concerns are hanging over markets as the conflict in the Middle East drags on in the background. The principal fear is that higher oil prices could raise inflation, which threatens to hit the economy at a time when growth was already slowing.

In March, El-Erian said he believed the economic damage from the Iran war was hitting a "tipping point" as regions around the world start to feel the pain of oil supply shortages.

Concerns have been building over the past year about the US losing its edge in markets over the rest of the world.

In a report last year, Goldman Sachs said it believed returns in the US market would likely lag behind the rest of the world over the next decade.

Forecasters at Bank of America and Apollo have also floated the idea that returns for the S&P 500 could be nearly flat over the next 10 years, an idea that's often dubbed as a "lost decade" for the US market.