PIMCO takes a long-term view of markets and economies, one that anchors investment decisions during shorter-term periods of market volatility. Nonetheless, the dramatic return of market volatility has understandably unnerved many investors. On 9 February, Daniel J. Ivascyn, group chief investment officer, and Scott Mather, CIO U.S. core strategies, updated clients on the dynamics at play. They discussed both the short-term, cyclical phenomena of the past week and the long-term, or secular, factors stretching out multiple years. They also address positioning portfolios for what’s ahead.
Volatility in perspective
The backdrop for the spike in volatility is more cyclical than secular in nature and unique to this business cycle. The main point to consider is that we are, finally, returning to normal levels of volatility.
- The U.S. economy is running close to capacity, and we are seeing a historically large dose of fiscal stimulus late in the cycle. This has implications for economic growth and inflation.
- The recent budget deal in Washington further demonstrates Congress is willing to allow deficit spending.
- At these levels of volatility, we do not anticipate a spillover into the real economy. However, volatility is likely to persist, and that could increase the risk of such a spillover over time.
- Volatility is a function of starting valuations, which have been somewhat stretched in equities and certain segments of the fixed income markets. So markets are more easily spooked by negative news.
- Credit is less volatile than equities, but this masks some risks and weaknesses in credit markets that could create opportunities for investors.
The macro view: The Fed and inflation
Our secular view since 2009 has been that we are in a New Normal, later revised to The New Neutral, global environment characterized by strong disinflationary pressures and relatively low and stable economic growth.
- We still hold this New Neutral view, though we regularly test the thesis in discussions with colleagues and with our expert advisors.
- Our base case is for the global economic expansion and inflation to continue at a moderate pace.
- However, we recognize near-term inflation risk is a legitimate concern for investors.
- We expect fiscal stimulus will add a slight boost to the U.S. economy, and inflation might meet or exceed the Federal Reserve’s target this year.
- Recent market events have not meaningfully affected the real economy, and with fiscal stimulus in place, we believe the Fed will make three hikes that will take the neutral rate to the low 2’s by the end of 2018.