Mohamed El-Erian, the chief executive of top bond fund manager PIMCO, on Tuesday said the rally in U.S. stocks had topped out because valuations have shot up too quickly.

Asked if U.S. stocks have hit a wall, El-Erian told Reuters Television: I think we have, and I think what you are seeing is a massive tug of war going on.

World stock markets fell Monday, with the Dow Jones industrial average <.DJI> declining 2 percent and China's Shanghai Composite Index <.SSEC> falling 5.8 percent, shaking off recent optimism amid doubts about the sustainability of a solid economic recovery.

On the one hand, pushing stocks higher are powerful technicals, the fact that very low yields on the front end have pushed cash out of the money market segment and into the risk assets, El-Erian said. But on the other hand, the fundamentals are such that valuations are ahead of fundamentals. What you have seen over the last couple of days is a recognition that fundamentals matter.

The global equities rally has been tempered by surprisingly weak economic data. On Tuesday, data showed U.S. housing starts unexpectedly fell in July, while the inventory of total houses under construction fell to a record low. Last week the Reuters/University of Michigan consumer sentiment survey showed a growing number of Americans were increasingly worried over jobs and wages.

El-Erian, who oversees $850 billion in assets for Pacific Investment Management Co, including equities, said U.S. stock markets have been on a sugar high as recent corporate earnings have surpassed expectations. But for the most part profitability has been driven by cutbacks in layoffs and capital spending, he said.

Moreover, the nascent economic recovery in the United States faces massive headwinds, including high unemployment, which translates into a vulnerable consumer, and weak private demand.

PIMCO has reduced risk in its portfolio as the rally has gone too far, El-Erian said, adding the firm has been a net seller of mortgage debt over the past few weeks.

El-Erian said PIMCO participated in last week's 30-year Treasury bond auction.

(Reporting by Jennifer Ablan and Dan Burns; Editing by Padraic Cassidy).

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