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Tomorrows Europe
Our secular view is that the status quo is not an option for the eurozone. In the near term, we believe it is more likely than not that Greece will exit the eurozone. While a Greek exit would likely be messy and volatile, our baseline view is that a smaller union will persist. To be sustainable, it will have to be underpinned by much stronger fiscal union, greater support for the banking system, and mutualization of debt to mitigate cross-border capital flight risks.
Snapshot on Spain: And the Money Keeps Rolling Out
by Francesc Balcells of PIMCO,
The severity of the Spanish financial crisis can be most vividly seen through the balance of payments data. March data shows net financial inflows of 533 million, but that includes ECB funding for the Spanish banks. When excluding the ECB funding, i.e., mostly private sector flows, the data shows 66 billion in outflows. In the past 12 months, 193 billion in private capital has left Spain, a whopping 18% of GDP.
Asset Allocation: Does Macro Matter? Part II
by Sebastien Page of PIMCO,
We see the conventional, valuation-based approach to asset allocation as akin to looking in the rearview mirror, which may lead to suboptimal investment outcomes when important macroeconomic shifts take place. We believe an econometric framework to assess the impact of shocks to GDP growth and inflation provides the missing link between macroeconomic forecasts and portfolio performance. Investors should constantly complement, review and revise qualitative and quantitative macroeconomic analyses with judgment, experience and a view on current events.
The Global Industrial Sector: Have Profit Margins Peaked?
by John Longhurst of PIMCO,
Factors driving profit margin expansion in the industrial sector include globalization, EM capital expenditures, a focus on profitability and global labour arbitrage.
Potential headwinds include a slowdown in global growth drivers, rising labour rates and global deleveraging.
We believe profit margins are most at risk in product areas where EM companies are benefiting from state capitalism and seek to take local advantages global.
Wall Street Food Chain
by Bill Gross of PIMCO,
Soaring debt/GDP ratios in previously sacrosanct AAA countries have made low cost funding increasingly a function of central banks as opposed to private market investors. Both the lower quality and lower yields of such previously sacrosanct debt represent a potential breaking point in our now 40-year-old global monetary system. Bond investors should favor quality and clean dirty shirt sovereigns (U.S., Mexico and Brazil), for example, as well as emphasize intermediate maturities that gradually shorten over the next few years.
Delayed Entitlement: The Changing Economics of Retirement
by Tom Streiff of PIMCO,
Its a foregone conclusion that Baby Boomers retirements will be very different from the retirements of their parents. To understand how, we need to explore the impact of the most recent financial events on Baby Boomers. The conventional wisdom is that as the leading edge of Boomers converged on age 65, their associated retirements are well underway and the economic and societal effects of this demographic-driven, transfer-payment-promised contingent are just beginning. In the next three to five years we should face a rapid and unprecedented expansion of entitlement expenditures.
Into the Great Unknown
by Andrew Balls of PIMCO,
Amid great uncertainty and huge challenges in Europe, it can be helpful to cut through all the detail and map out what we know and what we dont know. This is at best depressing and, at worst, terrifying. Taking together the known knowns and the known unknowns, it seems likely that the eurozones big four Germany, France, Italy and Spain as well as other German satellite countries will find a way to hang together in a smaller currency union backed by stronger regional co-ordination and financing mechanisms.
Loss Capacity Drives 401(k) Investment Default Evaluation
by Stacy Schaus and Ying Gao of PIMCO,
Based on our research, we believe retirement plan participants capacity for loss may be much lower than many investment default options accept as tolerable.
Regardless of asset allocation structure, an investment default option should maximize the likelihood that each plan participant will meet his or her retirement income needs.
One of the keys to meeting a set income replacement goal is to understand how much plan participants can afford to lose at every age as they approach retirement.
Why Invest in Asian Credit?
by Showbhik Kalra of PIMCO,
Asian sovereign and corporate credit offer more attractive yields than a number of other global fixed income sectors as investors take on additional risk. Given Asian markets diversity and the global macroeconomic environment, investors may wish to consider investment managers with a strong global macro process coupled with strong relationships with local stakeholders and experience in local portfolio management and markets.
Goodbye Planet Rates, Hello Planet Quantity: Credit Markets in a Zero Rate World
by Luke Spajic of PIMCO,
There is a sense that developed market economies are somehow undergoing a reversed metamorphosis reverting from butterfly back to caterpillar where growth is crawling as opposed to flying. The fear of credit destruction, perhaps triggered by deflationary scares, becomes a bigger obsession for central banks. The culture of credit risk-taking changes as rates go lower and approach zero with a perennial risk of the economy tipping into deflation.
Global Shipping: Any Port in a Storm?
With the exception of LNG tankers, all three major shipping categories have been suffering from a supply glut. This, combined with higher fuel costs, has led many shipping companies into financial distress. Although banks have worked with ship owners through this down cycle, they have also pulled back from financing the industry. We believe downside risks are likely minimized in the shipping industry for new lenders and investors. Vessel values are depressed by rates that are sometimes below owners' operating costs and by an oversupplied market that suppresses secondary market values.
Avoiding a Cold Shower in the Cash Markets
by Jerome M. Schneider of PIMCO,
A concern for investors would be to vigilantly monitor the global marketplace for any changes in the liquidity markets, reviewing aspects and conditions in both the unsecured and secured markets. The second source is the capital market participants themselves. Reduced or reallocated dealer balance sheets have led to wider bid-offer spreads in the marketplace. The final evolutionary condition to monitor is the regulatory environment in the U.S. The SEC and the Fed have recently become critics of the current structure of 2a-7 money market funds.
Policy Confusions & Inflection Points
by Mohamed A. El-Erian of PIMCO,
During this important annual event, PIMCO colleagues from around the world debate the major trends that will play out over the next three to five years, focusing not on what should happen, but what is likely to happen. Based on the 2012 Secular Forum discussions, we expect three themes to play out: continued policy and political confusion, overly incremental public and private sector responses and, therefore, greater potential for inflection points. In terms of regions, the status quo is no longer an option for Europe.
Equity Investing: From Style Box to Global Unconstrained
by Andrew Pyne of PIMCO,
PIMCO sees greater potential benefit to global portfolios in strategies that are unconstrained by a benchmark, and with managers who think about absolute return at least as much as they think about relative return. We believe the style box approach resulted in too great a focus on returns relative to a very narrow index and led investors to have too short of an investment time horizon in which to evaluate their managers, and that the cycles of style performance and the narrow benchmarks in the style box world encourages manager turnover and undermines long-term portfolio return potential.
Brazil: Compelling Opportunities for the Long Term
by Brigitte Posch of PIMCO,
Although economic growth has moderated somewhat in recent years, Brazils growth story remains compelling.
Underpinned by favorable GDP growth, Brazilian bank fundamentals are solid; banks are closely regulated and well-capitalized.
PIMCO believes several key corporate sectors oil, gas, utilities, infrastructure and major banks will dominate the outlook for Brazil over a secular horizon thanks to stronger pricing power and improved profitability.
Benchmarking Tail Risk Management
by Vineer Bhansali of PIMCO,
While tail risk hedging is a critically important area of modern portfolio management practice, the relative newness of the area means standard frameworks for benchmarking such portfolios have not developed. In fact, weve found that once the framework for proper tail hedge construction is defined based on key guidelines (including exposures, attachment, cost, and basis risk), the task of creating a proper index becomes relatively straightforward. To compensate for insufficient real-time performance measurement, tail hedges need to be evaluated on the basis of scenario analysis.
Going Global Can Pay Dividends
In todays low yield environment, many investors now include dividend-oriented equities in their portfolios in an effort to reach their income goals.
U.S. investors with home market bias risk severely limiting their income potential because in the U.S., dividend payout ratios are on the decline, taxes are potentially on the rise, and valuations in sectors that typically offer attractive dividends are near historical highs.
In our view, global equities can provide more attractive dividend income opportunities and offer potential for additional benefits, including diversification
When Quality Pays: A Fundamental Approach to Pursuing Lower Risk and Higher Returns
by Chuck M. Lahr of PIMCO,
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.
European Elections Complicate Outlook
by Mohamed A. El-Erian of PIMCO,
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.
Back In
by Mark Kiesel of PIMCO,
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.
Watchful Waiting
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.
Rethinking Best Practices for Bank Investment Portfolios
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.
Tuesday Never Comes
by Bill Gross of PIMCO,
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.
Wind Shear Avoidance: Why There Is Value in Momentum
by Vineer Bhansali of PIMCO,
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.
TIPS for Value Investors: Whos Afraid of Negative Yields?
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!
The Shrinking Social Security Trust Fund: Are We Really Surprised?
by James Moore of PIMCO,
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.
Decoding Duration to Better Understand Your Portfolio
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.
How European Politics Could Impact Markets
by Mohamed A. El-Erian of PIMCO,
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.
Release Oil from the SPR? Better to Take the Long View
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 Elusive Equilibrium: How Financial Markets Shape Global Rebalancing
by Ramin Toloui of PIMCO,
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.
Asia-Pacific Portfolio Committee on PIMCOs Cyclical Outlook
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.
What the Return of Market Volatility Tells Us
by Mohamed A. El-Erian of PIMCO,
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.
Dutch Disease Lite in Australias Economy
by Robert Mead of PIMCO,
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.
Newtonian Profits
by Neel Kashkari of PIMCO,
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.
Evolution, Impact and Limitations of Unusual Central Bank Policy Activism
by Mohamed A. El-Erian of PIMCO,
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.
Emerging Market Rates: A Different Cycle
by Francesc Balcells of PIMCO,
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.
Markets Wake Up to Central Banks' Complicated Tradeoffs
by Mohamed A. El-Erian of PIMCO,
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.
Global Equities: Building a Research Mosaic for the Information Age
by John Longhurst of PIMCO,
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.
Beyond Bonds: The Role of Risk Assets in Liability-Driven Investing
by Sebastien Page of PIMCO,
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.
To QE or Not to QE
by Tony Crescenzi of PIMCO,
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.
Auctions Never Fail!
by Lorenzo Pagani of PIMCO,
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.
The Great Escape: Delivering in a Delevering World
by Bill Gross of PIMCO,
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: Rise and Shine
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.
Transmission Channels
by Neel Kashkari of PIMCO,
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.
Andrew Balls Discusses PIMCO's European Cyclical Outlook
by Andrew Balls of PIMCO,
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.
Western Medicine
by Neel Kashkari of PIMCO,
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.
Investment Management with a Conscience
by Douglas Hodge of PIMCO,
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."
You Can No Longer Say Corporates Without EM
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.
Systemic Risk, Multiple Equilibria and Market Dynamics What You Need to Know and Why
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.
PIMCO Cyclical Outlook: Navigating the Hurricane of Global Deleveraging
by Saumil H. Parikh of PIMCO,
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.
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