An Insecure Stability
In a world in which stability is becoming increasingly unsustainable, how do we invest? Below are some of the key secular themes that we expect to guide how we manage our clients’ assets over the next three to five years.
1. Stay on dry land and preserve capital
In recent years we have described “riding a wave” of central bank interventions. Looking out over the secular horizon, however, diminishing returns to central bank interventions – and the potential for policy activism to do more harm than good, notably in the case of negative policy rates – advise against such an approach. Debt levels globally remain very high, and the more levered sectors are relying on (potentially less effective) central bank support. While our baseline secular outlook sees a fairly benign macroeconomic path and fairly range-bound markets, there are a range of downside risks, including China and the eurozone, monetary policy exhaustion, political gridlock and the rise of populism. These potential shocks to the global economy increase the prospects for permanent debt write-downs over the secular horizon. Overall, we expect to have more cautious positioning in our portfolios, and to make capital preservation the number-one priority. It will be critical to target high quality income-generating assets in our portfolios but not necessarily the highest-yielding assets – we will tend to look for structural seniority, and we want to see sufficiently strong fundamentals or hard asset coverage to help investments weather the uncertainties over the secular horizon. We cannot rely solely on central bank support. The secular timeframe is likely to remain a very difficult environment for investing, and we will seek to avoid investments where there is a real risk of permanent capital loss.
2. Guard against negative yields and guard against the asymmetric risk of rising yields
Markets now price in the New Neutral outlook for central banks and for market rates, which has been a central theme of our secular outlook for the past two years. Over the coming secular horizon, we will guard against negative yields in Japan and the eurozone, looking for more attractive global alternatives. Overall in our baseline outlook we expect government bond market yields to be fairly range-bound, but there is a clear asymmetric risk toward higher yields than those priced into forward curves.
3. Grind out alpha in a low return environment
We see this as an environment in which active managers can improve upon low passive returns. We believe critical decisions have evolved beyond the straightforward how much of a given asset class, sector or region to own in a portfolio, and instead see a need for greater discretion in selecting what to own.
4. Seek to benefit from periods of high volatility
While maintaining overall fairly cautious portfolio positioning, we will seek to benefit from periods of volatility in which assets have the potential to cheapen significantly. To be in a position to benefit, we will need careful portfolio construction and rigorous risk management of our positions.
5. Very selective on the eurozone
The eurozone secular outlook in particular is subject to a series of risks – economic, political and regulatory – and significant uncertainty over the reliability of property rights and the protection of the rule of law (recent examples of the latter include Portugal and Austria). In recent years we have favored eurozone markets with a secular bias to be overweight but, at current valuations and given the risks to the outlook, we expect to be cautious and very selective on eurozone holdings in our portfolios.
6. Look for opportunities in emerging markets
Our secular outlook of broad stability for the U.S. dollar, in part owing to China’s constraint on Fed policy tightening, along with commodity markets that have largely repriced to China’s reduced and less commodity-intensive growth path suggests that two key negatives for emerging markets have been removed. We will look on a country-by-country and sector-by-sector basis for good investment opportunities in emerging markets.
7. Bottom-up over beta
In credit markets, where market beta valuations look fair but not cheap, we will seek to add value using our global team of credit portfolio managers and credit analysts, focusing on picking the winners and avoiding the losers in the capital structure and investing in industries and companies where we perceive pricing power and barriers to entry.
8. Scour the world and diversify
We will scour the world for investment opportunities across sectors and look to take a wide range of diversified positions and to identify attractive liquidity and complexity premiums – and we will strive in portfolio construction and risk management to guard against excessive correlated risk in our portfolios.
9. Guard against the right tail
As well as seeking to protect against left tail risks, we need to seek to protect against right tail risks, given the possibility of better-than-expected macro outcomes – notably inflation, which, along with default risk, constitutes in our opinion the biggest risk to fixed income portfolios, particularly at very low levels of real and nominal yields. Given the extent of increasingly experimental monetary policies in place globally (with the potential for more to come), all with a core objective of boosting inflation rates, we find inflation protection is attractively priced.
For more insights into PIMCO’s longer-term economic outlook and what it means for investors, read “The Global Outlook: Stable But Not Secure.”
PIMCO is a global investment management firm with a singular focus on preserving and enhancing investors’ assets.
All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Inflation-linked bonds (ILBs) issued by a government are fixed income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Management risk is the risk that the investment techniques and risk analyses applied by PIMCO will not produce the desired results, and that certain policies or developments may affect the investment techniques available to PIMCO in connection with managing the strategy. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision.
This material contains the opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2016, PIMCO.
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