Determining which fundamentals may lead to higher returns would give equity investors a useful tool for constructing portfolios. Quality can be defined for equities by analyzing fundamental factors, such as operating margin, leverage (debt to equity ratio) and dividend yield. The factors that define quality tend to lead to lower risk in individual equities. As these fundamental factors in part lead to lower volatility, they may also lead to higher returns to the extent the stocks participate in the low volatility anomaly.

Markets will likely price in a larger risk premium following Sundays election outcomes on account of political uncertainty and the related range of specific risk factors, including greater concerns about creditworthiness and eurozone exit. This speaks, first and foremost, to the spreads of certain European sovereigns, with negative spillover effects on equities and other risk assets. Fortunately, there is a silver lining, though it will take some time. It comes in the form of a hope that the electorates message on Sunday will be interpreted by Europes leaders as a call for bold action.

U.S. housing may be a decent place to put money over the next several years due to improved absolute and relative valuations. U.S. housing fundamentals have improved significantly, led by lower prices, record low mortgage rates, improving inventory and delinquency trends and a gradually improving labor market, which in combination are helping homebuyer confidence and potential demand. While the outlook for U.S. housing has improved, several headwinds remain, including tight credit, potential supply from the shadow inventory and weak household formation due to a subpar economic recovery.

Today, the Federal Reserve itself faces an unusually uncertain period because it lacks a complete understanding of the potential side effects of its unconventional policy actions; in particular the elongated timeline of its zero interest rate policy and its massive money printing. What matters in shaping market expectations about inflation and deflation are the credibility of fiscal policy, the prospect for real economic growth and the central banks commitment to step back from the punch bowl.

The turmoil in capital markets and changes in the regulatory environment have sparked changes in bank investment portfolios and caused many banks to reevaluate portfolio management practices. Banks without the resources to develop new processes may be forced to limit their investment opportunity set, possibly limiting earnings and diversification potential in the securities portfolio. The investment portfolio may represent an opportunity to improve bank revenues and risk-adjusted performance by expanding into investments with improved return and diversification potential.

The current acceleration of credit via central bank policies will likely produce a positive rate of real economic growth this year for most developed countries, but the structural distortions brought about by zero bound interest rates will limit that growth and induce serious risks in future years. Gradually higher rates of inflation should be the result of QE policies and zero bound yields. Focus on securities with shorter durations bonds with maturities in the 5-year range and stocks paying dividends that offer 3%4% yields. Real assets/commodities should occupy an increasing percentage.

Explicit tail hedges that look expensive in a normal world may indeed turn out to be cheap if the unimodal morphs into the bimodal. When faced with bimodal outcomes, momentum as a risk factor becomes potent, and cost-efficient exposure to momentum becomes critical to proper portfolio construction. In this world of low, pegged interest rates, an investor who is going to take risk needs other means to make the portfolio more inured to unforeseen shocks and market storms. Investors should look at effective alternative beta strategies, such as momentum, that can be implemented efficiently.

Why wasnt the recent TIPS auction a blockbuster among Main Street investors? We believe they were frightened away by the -1.08% real yield. We would argue that the negative real yields that are explicit in TIPS also represent the implicit discount rate for ALL financial assets in the U.S. Moving away from TIPS into nominal yield is a bet on inflation being less than 2% for the next five years and less than 2.25% for the next 10 years a pretty bold bet!

If trends continue, it is quite possible that the OASI trust fund could run out of money in little more than a decade. Over the past five years the exhaustion date of the OASI trust has been brought forward by eight years. We are heading in the wrong direction. What is causing the shortfall? Setting aside the actuarial ps and qs, the core of the problem comes down to mortality, demographics and growth. The most likely solution will be lower indexation of wage growth for benefit determination, delayed retirement for those set to retire in 10 or more years and higher taxes for everyone.

Duration is often used as a shorthand way to communicate the interest rate risk of a fixed income portfolio. We frequently encounter duration quotations presented as though no subtleties exist. These quotations average duration exposures across maturities and across currencies, implicitly assuming that yields across maturities and currencies are equally volatile and perfectly correlated. We approach the task of understanding interest rate risk with a more complete view of the risk dynamics driving interest rate sensitivity.

Fed up with how all the economic, financial and policy news out of Europe have been contributing to equity market volatility? Well, not only will this continue but, now, we must also get ready for something new over the next few weeks: the impact of elections. In addition to their consequential national impact, the series of forthcoming elections involve cross-border implications that influence prospects for regional policy coordination and, therefore, the nature and speed of the solutions for Europes debt crisis.

A temporary release aimed at influencing short-term prices could actually send an unintended bullish signal to the market that long-term spare capacity in OPEC producers is insufficient to meet supply losses. After the release of oil from the SPR in 2011 prices initially fell by 7%, but quickly rebounded as the market priced in the challenge of redelivering the oil to the SPR in the future. With few options, governments have limited ability to influence oil prices and so should focus instead on policies that impact the medium to long term.

The mental and organizational infrastructure in the asset management industry has been built for a world with a sharp dichotomy between developed countries and emerging markets. Effective portfolio management requires an integrated approach that eschews the traditional dichotomy between developed and emerging markets. Emerging markets account for about 36% of global output and 68% of global GDP growth, but only represent about 4% of the equity portfolios of U.S. investors. We believe the representation in bond portfolios is even lower.

We do not expect to see aggressively expansionary policy to combat the incremental economic slowdown in China. We believe that most countries in emerging Asia will continue to put their currency appreciation on hold, as inflation is expected to remain subdued over the cyclical horizon. We are concerned about the sustainability of Japans economic growth beyond 2012, as the governments reconstruction spending will fade in 2013. Relatively speaking, Australia is indeed a beneficiary of higher commodity prices as a result of the strong demand for coal, iron ore and liquid natural gas.

Signals of a challenging outlook are much louder in European bond markets. Last week, yields on peripheral government securities went from flashing orange to again flashing red, with Spanish risk spreads near or at record levels. All this speaks to the unsettling situation of markets that remain highly dependent on policymakers who, themselves, are stuck in the muddled middle: unable to deliver sustainable outcomes or to exit from their market interventions. This is the unfortunate reality of an "unusually uncertain" outlook, blunt policy tools, and a rather dysfunctional political context.

Australia is probably more likely to feel the effects of an extended structural change in the economy as resources continue to be reallocated, rather than the effects of a full-fledged, but transitory, case of Dutch disease. China is Australias largest trading partner, and Chinas historical focus on infrastructure building has amplified the divergence in Australias two-speed economy. We believe Australias strong initial conditions should help ensure that Commonwealth Government Bonds remain one of the worlds cleanest dirty shirts for risk-averse investors.

Today many equity investors are asking whether corporate profit margins can stay strong. Stock prices today are anchored on strong profits, hence investors intense focus on the sustainability of those profits. If they fall, stock prices are likely to follow. No doubt individual companies and sectors will face margin pressure. But for the equity market as a whole, our central scenario is for corporate margins to remain strong in the near future. We are buying individual companies we like based on our analysis of their own fundamentals in the context of the economic environment they are in.

I will speak in a central bank and to central bankers about the role of their institutions particularly the Federal Reserve and the European Central Bank in todays highly complex, perplexing and historically unusual policymaking environment. I will go further and try to link actions to motivations. And, when it comes to implications, I will attempt to put forward questions and hypotheses that, I believe, are critical for the future of the U.S. and global economies but for which I, like others, have only partial answers.

The business cycle in EM has been conducive to easing policy rates. Global growth decelerated noticeably in the second half of 2011, and this included most EM economies. While we expect EM local rates will move higher again as the business cycle progresses, the cyclical highs will likely be lower than the previous highs, reinforcing the secular trend towards lower rates. We like EM local rates with a strong credit quality, steep local curves and high real rates that may offer compensation for taking inflation risks. The local markets of Brazil, Mexico and South Africa all stand out.

This week's market action serves as a vivid reminder of how dependent valuations are on central bank policies, and especially the aggressive provision of liquidity by the Fed and the ECB. The question for markets thus boils down to whether central banks will do more; and the issues these institutions face are extremely and increasingly complex. The global sell-off started on Tuesday with the release of the minutes of the most recent FOMC meeting. They were read by many as signaling less eagerness on the part of the Fed to embark on yet another round of liquidity injections.

As a result of increasing correlations across the globe, identifying the best global franchise opportunities at attractive valuations is becoming increasingly important. We believe that taking a broader global perspective and comparing a companys valuation and growth outlook versus their global competitors is just as germane as looking at them relative to their country or region. Identifying Chinese and non-Chinese companies that will gain and lose in this process is a critical long-term challenge when constructing a global portfolio and not an easy one.

In liability-driven investing, unless the plan is fully immunized or significant leverage is employed, the bond portfolio only hedges part of the liabilities. Overall, when diversifying across risk assets, there are choices that may be more attractive to pension plans than they are to liability-agnostic investors, such as risk assets with exposure to duration. Plan sponsors who choose to maintain a short duration stance on a total portfolio basis should consider alternative sources of diversification beyond equities.

If the Fed does nothing, asset prices could fall, threatening Americas fragile economic recovery. But if the Fed decides to battle the forces of deleveraging, it could commit a classic error by acting during a turning point and thereby doing too much. During Operation Twist, the Fed will absorb the equivalent of all of the issuance of U.S. Treasury securities maturing beyond seven years. When Operation Twist ends, global investors will be left to shoulder the burden.

The increase in volatility can reach a breaking point when dealers are no longer willing to absorb risk and the issuer loses market access, irrespective of whether an auction fails or not. Individual countries are working to regain credibility and address their debt-sustainability but what is needed is an explicit collective commitment towards fiscal union. Catalysts for uncertainty may only be a few weeks away with the elections in Greece, France and a referendum in Ireland looming. Foreign investors who preferred to remain on the sidelines during the rally may reappear as sellers.

When interest rates cannot be lowered further or risk spreads significantly compressed, the momentum begins to shift, gradually yields moving mildly higher and spreads stabilizing or moving slightly wider. In such a mildly reflating world, unless you want to earn an inflation-adjusted return of minus 2%-3% as offered by Treasury bills, then you must take risk in some form. We favor high quality, shorter duration and inflation-protected bonds; dividend paying stocks with a preference for developing over developed markets; and inflation-sensitive, supply-constrained commodity products.

Regulated energy companies natural gas pipes, gas utilities and electric utilities have generally been seen as the sleepy cousins of more exciting energy subsectors like exploration and production, or coal extraction and production. But we have witnessed a number of events and regulatory developments in recent years that we believe are re-energizing the regulated energy subsector, more clearly distinguishing it from other members of the energy sector family and providing the potential for an abundance of opportunity for astute investors.

We believe the European debt crisis will likely flare up again, and equity investors should consider positioning portfolios to be more resilient against such a shock. A disorderly Greek default, if it occurs, would likely shock the eurozone and the globe via at least four transmission channels: the European banking system, European sovereign debt markets, corporate financing markets and regional trade. The shock of a massive Greek default would likely swing investor sentiment strongly toward risk off, putting pressure on equity markets globally.

The ECBs intervention has helped the European system undergo a slower and more orderly deleveraging process but it does not deal with the twin underlying problems of too little growth and too much debt in the countries at the center of the crisis. The eurozone faces a daunting set of challenges, including technical and economic challenges but highest on the list are politics and coordination. Greeces potential exit from the eurozone remains a significant risk and one that could lead to contagion across the eurozone as investors reassess the potential currency risk.

Liquidity is buying time for European countries, but their economies are growing too slowly to support their debt loads. Just as there is no reason to assume U.S. household debt levels will continue to climb, there is also no reason to assume companies that benefitted from that debt-fueled spending will grow at historical rates. Until we see sustainable, real economic growth in America, we believe equity investors should carefully scrutinize the assumptions underlying consumer discretionary stocks and consider global companies that are selling into higher growth markets.

Earlier this year the Financial Times ran a series of editorials under the title Capitalism in Crisis. Contributors ranged from Bill Clinton and Alan Greenspan to FT editors Martin Wolf and John Kay. There was also a submission with the byline, Occupy London. While I am admittedly unable to add much to their collective wisdom, I think a sound analysis of capitalism requires an understanding of the role of the investment management industry within the financial services ecosystem."

In our view, the risk profile for EM corporates has improved thanks to stronger sovereign balance sheets and economic growth prospects compared with developed markets. While EM corporates generally have not garnered as much attention as sovereigns, PIMCO expects that significantly more assets will be managed against an EM corporate bond index this year. The road ahead for risk assets may be bumpy. But PIMCO believes the case for focused EM corporate bond investing remains compelling based on improved credit fundamentals, a solid macro backdrop, and potentially attractive yields.

In assessing the possibility, duration and impact of systemic risk factors, we need to analyze the interaction of expectations with market (endogenous) and policy (exogenous) circuit breakers. In the current environment, the prevalence of some subjective bimodal expectation distributions (e.g. Europe related) speaks to the multiple equilibrium features of sovereign debt markets. Multiple equilibria give rise to a range of scenarios, each quite different and each with its own distribution of returns, risks, correlations, and market functioning.

We expect the eurozone economy to experience a recession in 2012 on the back of continuing pro-cyclical fiscal austerity measures. We expect 2012 to be the year in which the residential construction sector begins to gradually contribute to U.S. economic growth after a long and painful five-year hiatus. Major emerging market economies are struggling with domestic over-investment, rising income inequalities and inflation risks. Therefore, PIMCO expects major emerging market economies to be less of a global engine of growth in 2012-13.

Many of us have a responsibility, indeed an obligation, to do whatever we can to ensure that both conscious and unconscious biases are better identified and minimized. This is a multi-year, multi-faceted effort. As illustrated by the USAID policy, it involves research, education, advocacy and action; as well as measurement, accountability and mid-course corrections. For all these reasons, we admire the important work being done on gender equality and the empowerment of women. We strongly endorse the importance of greater and equal opportunities.

We believe nominal spread analysis is insufficient, since investors must now consider recovery and default risk under various economic conditions. Our factor-based approach provides a means to quantify default probabilities across a range of outcomes instead of analyst-defined ad hoc assumptions. We also investigate historical CDS spreads as a means to quantify default risk relative to national home price appreciation. The potential for an emerging U.S. issuer market, combined with ongoing foreign issuance, leads us to believe the U.S. covered bond market has viability.

The availability of high-frequency information, technological advances in electronic trading and the dominance of government and regulatory policy factors made the world since the crisis of 2008 a risk-on/risk-off environment. In January 2012, S&P 500 implied correlations began to fall. It appears that stocks are beginning to take a bit more of their individuality back so that other assets dont move in lock step. Investors may benefit from a focus on policymakers, relative value opportunities, hedging potential left tail events, and diversification.

The Eurosystem's TARGET2 transaction system introduces elements of fiscal union via the back door. The large TARGET 2 positions developing among national central banks in the eurozone reflect capital flight from the periphery to the core and de facto introduce transfer and burden sharing elements of a common fiscal policy. Monetary policy ends up substituting for fiscal policy without going through the same democratic channels that governments' expenditure and taxation decisions entail. Taxpayers in the eurozone are contingently liable for losses incurred by monetary policy operations.

Faced with difficult questions like the European debt crisis, portfolio managers have two possible courses of action: feign omniscience and seek to position portfolios for one outcome, or admit to not knowing the answer and seek to position portfolios to prosper in the most likely scenarios and hold ground in the least. We believe the latter is the better course because two extreme outcomes appear increasingly likely for almost all asset classes, which increases the risk involved in choosing the wrong answer.

Over the past 30 years, an offensively minded Federal Reserve and their global counterparts were printing money, lowering yields and bringing forward a false sense of monetary wealth. Successful investing in a deleveraging, low interest rate environment will require defensive in addition to offensive skills. The PIMCO defensive strategy playbook: Recognize zero bound limits and systemic debt risk in global financial markets. Accept financial repression but avoid its impact when and where possible. Emphasize income we believe to be relatively reliable/safe; seek consistent alpha.

Today, the primary emphasis in security selection must be placed upon creditworthiness and the relative value of credit spreads. When the spread on a bond more than compensates an investor for its underlying risks, the bond becomes an attractive candidate, PIMCO believes. Investors with the resources and process in place to conduct proprietary credit research may have a strong competitive advantage.

In addition to strong secular tailwinds supporting the energy sector, highly expansionary global monetary policies from many central banks are adding cyclical support to globally traded commodities like oil. In the U.S. energy sector, we believe that onshore natural gas shale and oil shale developments are creating opportunities to invest in energy companies that may grow significantly faster than the overall U.S. economy.

Given the bimodal nature of the expected distribution of outcomes, it is important for investors to remain nimble so they can respond to high frequency data and global public policy developments. We expect the Bank of Canada to remain in wait-and-see mode until it is clear which way the economy is tipping. In our base case scenario, we estimate Canadian bond market returns in the range of 2%-4%, and if we tip into a virtuous cycle of economic recovery, we anticipate the possibility of negative absolute returns.

Many governments are carrying higher levels of debt, which can increase both economic and asset volatility as well as default risk. The resulting incremental increase in default risk suggests pension portfolios may have less duration than implied by traditional measures. Pension plans with high levels of equity exposure should consider increasing durations and credit exposure. Investment guidelines may need to be adjusted so they dont measure credit risk simply by the World Banks definition of emerging markets.

Given the Feds targets for both inflation and long-run normal employment, the new framework suggests continued lower bound rates, forward guidance and potentially additional QE. The Fed explicitly extended the length of time that it expects interest rates to remain exceptionally low and kept the door open to adjusting at a future meeting the size and composition of its balance sheet. The Fed reached unanimous agreement on a published numerical inflation target of 2% that, in its judgment, best satisfies its mandate to achieve price stability.

There are way too many discomforting similarities between what has been happening in Greece recently and Argentinas 2001 path to economic and financial turmoil. Unless Greek and European officials reflect on key lessons from Argentina's experience back then, the parallels could also end up including a financial meltdown, a deep output collapse, and social and political turmoil. Greece need not and should not - continue to follow Argentinas example of eleven years ago.

Liquidity is buying time for European countries, but their economies are growing too slowly to support their debt loads. In the U.S., household debt is declining, but remains high. There is also no reason to assume companies that benefitted from that debt-fueled spending will grow at historical rates. Until we see sustainable, real economic growth in America, we believe equity investors should carefully scrutinize the assumptions underlying consumer discretionary stocks and consider global companies that are selling into higher growth markets.

Headline inflation, as measured by the Consumer Price Index (CPI) in the U.S., ran at 3.0% in 2011, up from 1.5% for 2010. Our base case is for inflation to moderate this year, heading to slightly below 2%. Longer term our bias is toward higher inflation, and we feel any deflationary episode is likely to be short-lived. Faced with this possibility of higher inflation, many investors may need to examine their allocations to assets associated with real return potential, including Treasury Inflation-Protected Securities (TIPS), real estate, commodities and equities.

Revenue growth rates at many large investment grade technology companies have declined in recent years while debt issuance has risen, in part because of nearly full market penetration in certain high-tech products but also due to less innovation. PIMCO is very selective in the investment grade tech sector, favoring companies with strong and growing patent portfolios in areas of secular growth, strong free cash flow generation and low leverage.

The first Friday of every month, you will find me among those eagerly waiting for the release of the latest government data on jobs. Such eagerness, however, should not be confused with joyfulness. While the numbers have markedly improved over the past year, too much of the commentary has been overly partial and, sometimes, dangerously misleading a situation that is likely to grow worse in the run-up to the November elections.

Volatility has soared in the cash markets as the eurozone crisis has deepened, prompting many investors to pull cash out of prime money market strategies over the last year. With U.S. interest rates on hold until 2014 and regulations on 2a-7 money market strategies putting pressure on yields, cash investors will likely face near-zero yields for several years. In this environment, we believe investors should reassess their liquidity needs and consider putting cash that is not needed right away into short and low duration instruments instead of money market strategies.