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The Squeeze Play
by Jerome Schneider of PIMCO,
Reductions in Treasury bill and commercial paper issuance compounded by developments on the demand side mean the squeeze play is on for many short-term portfolios. Investors should consider the potential for substantive changes to liquidity conditions as banks contend with increases in capital requirements due to updated Basel III regulations. Active management of short-term investments is important: Dont rely on static regulatory frameworks or traditional indexes to determine a portfolios unique liquidity needs.
Getting Serious About Investing Responsibly
by Luke Spajic, Josh Olazabal of PIMCO,
To date, much of ESG-related investing has focused on negative screening, but we believe there is a better approach. This approach rests on three pillars: identifying and analyzing key ESG issues facing a given investment sector, engaging with the issuers of securities, and supporting the development of markets for ESG investments.
Taper Time - Mining, That Is
by Adam Bowe, Robert Mead of PIMCO,
Recent data suggest that mining investment is tapering, with the sector detracting from real growth in the first half of 2013. We see three possible growth scenarios: a handoff to the corporate sector; no handoff, with demand continuing to slow; or a handoff to the highly levered household sector, which would create long-term risks. Until we see meaningful signs of a growth handoff from the mining sector to a new balance sheet that has the capacity to expand, our base case calls for sub-trend growth and low interest rates, supporting bond prices over the cyclical horizon.
The New Normalization of Fed Policy
by Tony Crescenzi of PIMCO,
The Fed is sending a message that the unwinding of its extraordinary accommodation will be done with great care and patience, and will take time - a long time. In delaying a taper, not only did the Fed show markets it has little tolerance for any tightening of financial conditions, it also strengthened its forward guidance considerably. The Feds decision to delay a taper will likely relieve some of the upward pressure on longer-term interest rates.
After Detroit: Rigorous Research and Credit Selection Is the Key to Investing in Municipal Bonds
by David Hammer, Sean McCarthy of PIMCO,
Detroit recently declared bankruptcy, setting off the largest municipal Chapter 9 proceeding in history. There has been and will continue to be a lot of noise in the media, underscoring challenges but also presenting opportunity for experienced investors. PIMCO has long favored special revenue essential service bonds over GO bonds. Detroit Water and Sewer bonds are payable by a pledge of and statutory lien on net revenues of the water or sewer system, and as such benefit from provisions in the federal bankruptcy code ensuring that the pledge is not affected by the petition.
Washington's Prolonged Saga and the Market's Reaction
The federal government shutdown represents yet another self-inflicted wound to already modest growth. While the market seems to be mostly sanguine about the government shutdown, a breach of the debt ceiling which we feel is highly unlikely would be incredibly negative for financial markets.
Survival of the Fittest?
by William Gross of PIMCO,
I hate crows and my wife Sue hates bugs, but like most married couples we have learned to live with our differences. Crows eat bugs though, and bugs eat bugs, and that scientific observation sets the context for the next few paragraphs of this months Investment Outlook.
PIMCO Cyclical Outlook for the Americas: A Slow-Moving Fed Benefits Economies on Both Continents
PIMCO expects the U.S. economy to grow 2.0%2.5% over the next year. However, a continued government shutdown would be a drag on growth. In Latin America, we see growth picking up to 3.0%3.5%, but the outlook varies by country. Mexico should fare well, but Brazils story is more mixed. In Canada, we believe the housing correction will be less severe than many are predicting, and we expect GDP to grow 1.5%2.0% over the cyclical horizon.
Investing In Corporate Bonds: The Compelling Case For Active Management
by Ed Devlin, Michael Kim of PIMCO,
Passive investment returns in the Canadian corporate bond market have been unimpressive because of the way corporate bond indices are constructed and factors unique to the Canadian market. Unconstrained by these limitations, active managers with global reach may provide superior returns. The current environment presents an attractive opportunity for Canadian investors to implement a wide discretion, active approach to managing corporate bonds.
PIMCO Cyclical Outlook for Europe: Near-Term Recovery, Long-Term Risks
by Andrew Balls of PIMCO,
While Europe has emerged out of recession, the relative tightness of monetary policy means the eurozone is still struggling to get back to potential pre-Lehman growth rates. The European Central Bank should be able to maintain stability over the cyclical horizon while policymakers continue to address outstanding issues as they look to build a less vulnerable monetary union. We are selective in our approach to regional credit and remain neutral on the euro, balancing our cyclical outlook with longer-term secular concerns on the eurozone outlook and valuations.
Secular Trends in Asian Credit Markets Shape Long-Term Investment Themes
by Robert Mead, Raja Mukherji of PIMCO,
The next several years will likely see many Asian corporate issuers to come to the market for financing, whether to pursue long-term business plans or to employ traditional corporate finance and leverage strategies. Rigorous credit research, flexible resources, experienced local portfolio management and strong relationships with local stakeholders are all crucial to uncovering attractive opportunities while monitoring volatility in Asias credit markets.
The Euro Tug-of-War
by Thomas Kressin of PIMCO,
Faced with lingering economic stagnation, record unemployment and continued political strife in the region, the common consensus for a depreciation of the euro seems only natural and very much required to counter the weak cyclical position of the eurozone. The rising current account surplus in combination with net long-term capital inflows point to a stronger euro that could stay with us for an extended period; such a development could potentially undermine the fragile social consensus to continue with the necessary structural and fiscal reforms.
U.S. Commercial Real Estate: Will the Good Times Last?
by Devin Chen of PIMCO,
The CRE market has experienced a gradual recovery in asset pricing since the 2008 financial crisis. Despite the duration of the recovery, there continues to be dislocation in the CRE market that astute investors can capitalize on. We believe certain properties in non-major markets look attractive for acquisition, and have been acquiring residential land on an opportunistic basis.
Growth and Rising Stars
by Mark Kiesel of PIMCO,
While developed market growth in several regions is picking up cyclically from low levels, overall global economic growth should remain subdued over the next several years. We believe credit spread tightening and rating upgrades are most likely for specific companies in industries and areas with strong growth. We see these "rising star" companies in the U.S. and European auto sector, the gaming, energy and chemical industries and in sectors tied to the U.S. housing market.
A Fine Balance in the Global Profits Cycle
by Saumil Parikh of PIMCO,
In the U.S., we expect growth to accelerate over the cyclical horizon, but to disappoint elevated consensus expectations. In Europe, we also expect growth to accelerate, but just barely, and also below consensus. In Japan, we expect growth to remain heavily reliant on aggressive fiscal and monetary policies. And in emerging markets, we expect a stabilization in growth assisted by central banks regaining control of currency and financial market conditions. The outlook for global corporate profits is a key measure of success in determining the handoff to self-sustaining growth going forward.
Is the Commodity Supercycle Dead?
While commodity price appreciation wont likely mirror the supercycle, this shouldnt necessarily imply a negative view on commodity returns going forward. We believe commodity prices are at reasonable levels from a long-term valuation perspective. In addition, the roll yield from investing in commodities is the highest its been since 2005. The outlook for commodity returns today seems broadly consistent with historical returns, and commodities remain an important tool for hedging inflation risk.
What's Happening to Bonds and Why?
by Mohamed El-Erian of PIMCO,
To say that bonds are under pressure would be an understatement. Over the last few months, sentiment about fixed income has flipped dramatically: from a favored investment destination that is deemed to benefit from exceptional support from central banks, to an asset class experiencing large outflows, negative returns and reduced standing as an anchor of a well-diversified asset allocation.
Seventh Inning Stretch
by William Gross of PIMCO,
They say that reality is whatever you wish it to be and I suppose that could be true. Just wish it, as Jiminy Cricket used to say, and it will come true. Realitys relativity came to mind the other day as I was opening a box of Cracker Jacks for an afternoon snack. Thats right I said Cracker Jacks! I cant count the number of people who have told me during the seventh inning stretch at a baseball game to make sure I sing Cracker Jack (without the S) because thats what the song says. I care not. No one ever says buy me some potato chip or some pea
Policy Uncertainty on the Rise
Congress seems to be digging in and ramping up the rhetoric in advance of a possible government shutdown, a debt ceiling increase and a probable selection of a new Fed chair. We think it is likely policymakers will agree to a short-term deal to fund the government and avert a shutdown, and also cobble together a resolution on the debt ceiling, although neither is likely until the last minute. The Fed chair debate will likely continue to sway markets over the next few months, leading to greater uncertainty and greater market volatility.
Purgatory Is Heaven
by Tony Crescenzi of PIMCO,
Since June, the Fed has stressed three messages: Tapering is not tightening, the federal funds rate will not move in tandem with a slowdown in asset purchases, and any change in Fed policy will rely on data, rather than a date. If Ben Bernanke leaves the Fed when his term expires, whoever is chosen to replace him will be bound by rules and the strength of the institution. The outlook for interest rates depends more on the Feds overall approach to the policy rate, and PIMCO believes the Fed will not increase that rate until 2016.
Using Equities to Hedge Inflation? Tread With Care
by Bob Greer, Raji Manasseh of PIMCO,
Historically, broad equity returns have not intrinsically provided a good hedge against inflation. Three key attributes may help companies withstand inflationary environments - pricing power, supply side advantages and a willingness and ability to sustain dividend hikes at a rate faster than inflation. To realize equities long-term potential as a key source of portfolio returns, investors should consider enlisting active managers who select stocks with a view on inflation and its effect on specific companies.
What Role for Emerging Markets After the Sell-Off?
by Ramin Toloui of PIMCO,
While history suggests that the sell-off in emerging market bonds could ultimately offer attractive buying opportunities, it is important to anchor investment decisions firmly within a forward-looking economic and market outlook. Continuing vulnerabilities in global growth suggest there is fundamental value in EM bond yields at present valuations, as interest rate hikes priced into EM yield curves are unlikely to materialize in an environment of tentative growth.
Bond Wars
by William Gross of PIMCO,
Adaptation is tantamount to survival in the physical world. So argued Darwin, at least, and I am not one to argue with most science and its interpretation of natural laws. Adaptation has been critical as well for the survival of countries during wartime, incidents of which I am drawn to like a bear to honey, especially when they concern WWI. Stick with me for a few paragraphs on this the following is not likely to be boring and almost certainly should be instructive.
Alternatives for Today's and Tomorrow's Market Challenges
Investors should consider alternative investment strategies, which could enhance diversification and the potential for alpha, or risk-adjusted returns, because returns from traditional asset classes in coming years may be lower and more volatile than those realized historically.
Calm Has Replaced Fear in the Bond Market
by Tony Crescenzi of PIMCO,
Calm largely returned to the bond market in July following a bout of turbulence in June. Volatility declined across the broad spectrum of fixed income assets, with interest rates and credit spreads falling from their highs, in some cases dramatically. Flows have also turned positive in many market segments, particularly for high yield and bank loan securities.
Canadian Secular View: Into Darkness?
Many investors are buying Canadian federal government bonds, shorting Canadian bank stocks and selling Canadian dollars in anticipation of a prolonged downturn. While significant risks are clearly facing the Canadian economy, our baseline forecast does not justify positioning our portfolios for a prolonged Canadian downturn.
The Tipping Point
by Bill Gross of PIMCO,
Ive spun a few yarns in recent years about my days as a naval officer; not, thank goodness, tales told by dead men, but certainly echoes from the depths of Davy Jones Locker. A few years ago I wrote about the time that our ship (on my watch) was almost cut in half by an auto-piloted tanker at midnight, but never have I divulged the day that the USS Diachenko came within one degree of heeling over during a typhoon in the South China Sea. Engage emergency ballast, the Captain roared at yours truly the one and only chief engineer.
Stay the Course
by Douglas Hodge of PIMCO,
It is that time of the year again. As school schedules give way to summer vacations, many families will be packing up the SUV to head to one of this nations amazing national parks. Years ago, my young family traveled to Yellowstone National Park, home of Yogi Bear and Old Faithful. The requisite float trip down the Snake River was arranged and a good time was had by all a bit of spray but nothing too jarring. Only days later, I returned to the Snake River and had the ride of a lifetime.
Floating-Rate Notes: A New Frontier in Treasury Investing
For investors, Treasury floating-rate notes (FRNs) will likely offer a hedge against rising rates and a yield pickup over a T-bill. For the Treasury, FRNs could help reduce the risk that an auction could fail to attract customer interest, and also help diversify its investor base. PIMCO will evaluate the merits of these securities based on our macroeconomic top-down view and valuation-focused bottom-up analysis.
Efficient Pension Investing
by Jared Gross of PIMCO,
Adapting the Sharpe ratio to pension portfolios can help plan sponsors choose among a multitude of investment options designed to achieve the same goal. In our experience, the most significant efficiency gains have come from shifting from intermediate bonds to long-term bonds and introducing lower-volatility substitutes to equities.
Taking Seniority: Looking to Bank Loans in Uncertain Markets
by Elizabeth (Beth) MacLean of PIMCO,
Bank loans are senior secured loans to non-investment-grade corporations. They are floating rate instruments, secured by the collateral of that company and senior in the capital structure. Bank loans can be a more defensive way for investors to move into the high yield space, due to the collateral and their senior position. While we have seen yield spreads tightening among loans, on a relative basis we do think loan valuations still look attractive. PIMCOs investment process helps us seek these attractive opportunities while managing risk.
Promise to Be Irresponsible
by Jeremie Banet, Mihir Worah of PIMCO,
We believe the recent rise in real rates and fall in inflation expectations could jeopardize the U.S. economic recovery. We also believe these are a direct result of uncertainty about the Federal Reserves ultimate goal. Low real yields accompanied by sufficient nominal growth are the necessary prescription for a still ailing economy.
Which Way for Bonds? Mapping a Path Forward
by Bill Gross of PIMCO,
In 1980, the Federal Reserve, led by Paul Volcker, tightened the quantitative noose to tame double-digit inflation, fueling an unprecedented tailwind for bond prices. Thirty years later we find ourselves at the other extreme, as central banks print money in the trillions of dollars to stimulate economic growth, and inflation is abnormally low. While we are not likely to see a repeat of that type of bull market any time soon, we also do not believe we are at the beginning of a bear market for bonds.
How Asia's Growth Transitions and Policy Experiments Are Shaping the Global Outlook
Our view is that Chinese GDP growth will downshift, averaging 6%-7.5% for the next five years as net exports and investment are reaching their limits. In Asia, Japan is perhaps the economy closest to the T-junction described in PIMCOs global secular outlook: The destination of Japans journey looks increasingly uncertain, with multiple potential outcomes that could stabilize or destabilize the global economy and markets.
Managing the Odds: Overcoming Exit Strategy Biases with Tail Risk Hedging
by Vineer Bhansali of PIMCO,
Rather than making an exclusive choice we believe that rebalancing, options purchase and diversification should all be considered on the same footing. Is it better to dynamically de-risk if markets begin to fall to lock in gains, or is it better to purchase explicit tail hedges? Our tendency, as humans, to be time-inconsistent, with behavior changing as the situation changes, makes dynamic rebalancing prone to behavioral biases. At pricing levels of low option premia the purchase of options to prevent time-inconsistent behavior seems like a judicious decision.
Liquidity Markets Likely to Evolve Under Proposed Money Market Reforms
by Jerome Schneider of PIMCO,
We view the SECs proposed regulations on money market funds as a pivot point for cash and liquidity management. If the first proposal is adopted, prime institutional money market funds would convert to a floating net asset value share price. That conversion would likely cause some volatility in pricing. As we do not expect yields to increase in the near-to-medium term, in our view the risk-reward tradeoff would not be as attractive for investors.
A Longer Time Horizon Can Be an Advantage for Value Investors
by Mark Cooper of PIMCO,
We believe that given challenging prospects for attractive investment returns, the value premium could become even more important in the years ahead. Even in an uncertain environment like we are currently experiencing, we believe the merit in owning equities for the long term is unchanged: We want to participate as an owner in a growing, profitable business.
Broader Use of Bail-Ins Could Spur a Revival of Asset-Backed Securities in Europe
by Felix Blomenkamp of PIMCO,
We believe ABS issuance will likely increase in Europe as eurozone developments and possible future bail-ins potentially result in higher risk premiums and funding costs for European banks. Although regulators are playing catch-up, capital markets are making room for a more credit-intensive product, helping to lead the way for a resurgence in ABS. Due to concerns over the security of bank deposits, investors may look to the ABS sector, which offers collateralized bonds that are free of bail-in risk.
Will Green Shoots Flourish in U.S. and Latin America?
by Josh Thimons, Lupin Rahman of PIMCO,
The US economy is much further along the road to repair relative to its developed market peers, but it is still dealing with an unsustainable fiscal situation. Latin America is closely coupled to the rest of the world. What happens in the U.S., China and Europe over the secular horizon is especially critical. Our secular investment outlook calls for a more defensive posture toward risk. In U.S. fixed income, this suggests positioning for alpha rather than capital appreciation.
The Role of Cash in Multi-Asset Portfolios
Determining the optimal allocation to cash is as challenging as ever in todays unusually uncertain markets. When allocating to cash, investors should consider a multi-dimensional framework to assess the liquidity of the underlying cash instruments. In our view, the most attractive risk-adjusted opportunities for cash investors lie just outside the traditional money market space.
Wounded Heart
by Bill Gross of PIMCO,
Joseph Schumpeter, the originator of the phrase creative destruction, authored a less well-known corollary at some point in the 1930s. Profit, he wrote, is temporary by nature: It will vanish in the subsequent process of competition and adaptation. And so it has, certainly at the micro level for which his remark was obviously intended. Once proud, seemingly indestructible capitalistic giants have seen their profits fall short of everlasting and exhibited a far more ephemeral character.
Defense and Selective Offense
by Mark Kiesel of PIMCO,
Given the markets newfound risk appetite for credit and less attractive valuations, we are taking advantage of global credit market liquidity in an effort to reduce our overall risk posture. In our selective offense approach, we continue to favor U.S. housing and housing-related areas, in addition to select investments in the energy, pipeline, specialty finance, gaming, hospitals, and airline and auto industries, given the more positive fundamental outlook for these sectors.
Into the Woods
Excess liquidity, falling net issuance and higher correlations among assets complicate the eventual exit that the Federal Reserve and other central banks must make from their extraordinary policies. The Bank of Japans ideology has completely changed to tackling deflation from tolerating deflation. The key focus in the coming months will be how private sectors react. Investors who depend chiefly upon central bank activism may put themselves at risk. They may need to hedge volatility by ensuring their investments are built more on solid fundamentals and reasona
In an Era of Uncertainty and Lower Returns, It's Time for Alternatives
The initial economic and capital market conditions of the 1980s set the stage for a multi-decade bull market for stocks and bonds. Times have changed, however, and traditional investment portfolios are unlikely to deliver returns as healthy as those enjoyed for much of the last 30 years. Its time to think alternatively about asset allocation and index construction, sources of alpha and beta, and risk and return objectives to increase the probability of success in what we believe is a new era for investors and financial markets.
Global DC Plans: Similar Destinations, Distinctly Different Paths
DC plans in in the U.S., Australia and the U.K. may benefit from better aligning asset allocation defaults to workers needed outcome: purchasing power in retirement. Focusing on needed outcomes would suggest a higher allocation to real assets, earlier de-risking and consideration of tail risk hedging.
Reflation in the Balance
by Richard Clarida of PIMCO,
Four of the worlds major central banks are now all in when it comes to ballooning their balance sheets in correlated, if not coordinated, efforts to achieve escape velocity in their economies. In accounting for the impact of quantitative easing on two key balance sheets, we are able to interpret, monitor and calibrate the programs currently in place. This in turn can help us prepare portfolios if or when sentiments and inflation expectations shift.
UK Secular Outlook - Morphing into the Carney Era
The UK remains in a stable disequilibrium, one that needs to either transform into growing economy with narrowing income differentials or risk a more aggressive policy response. Financial repression, protection of real purchasing power, tail risks of accelerated currency weakness and price sensitivity will likely dominate UK markets over the secular horizon. Investors may consider progressively reducing exposure to assets susceptible to tail risks. Higher quality short-dated income-generating, inflation-hedging and non-sterling assets remain attractive.
Filling the Hole We Have Dug
by Adam Bowe, Robert Mead of PIMCO,
Mining investment contributed more than 60% of the growth in Australias GDP in 2012. The expected decline in mining investment will likely leave a significant economic hole in the short term that needs to be filled. PIMCO expects easier monetary policy will be needed to support other sources of domestic growth, such as non-mining business investment, household consumption and housing construction.
Europe's Crossroads: The End of the Muddle Through?
by Andrew Balls of PIMCO,
The eurozone may be nearing a critical junction, owing to its weak growth, weak institutions, debt dynamics and domestic and cross-border political challenges. The German government may take a more active leadership role after its national election, but it is more likely it will continue with piecemeal measures. Considering the current low yield environment and ample central bank liquidity, it is important to focus on absolute yield levels and returns, and consider global alternatives such as emerging market securities and currency exposure.
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