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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.
Remarks at the Launch of USAIDs Policy on Gender Equality and Women Empowerment
by Mohamed A. El-Erian of PIMCO,
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.
U.S. Covered Bonds: Reassessing Credit Risk and Relative Valuations
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.
Beyond Risk-on/Risk-off: Paying Heed to Peripheral Cues in Portfolio Construction
by Vineer Bhansali of PIMCO,
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.
TARGET2: A Channel for Europe's Capital Flight
by Andrew Bosomworth of PIMCO,
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.
Positioning Your Portfolio When You Dont Have All the Answers
by Josh Thimons of PIMCO,
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.
De-Fence
by Bill Gross of PIMCO,
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.
Credit Counts: The New Municipal Bond Market
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.
Game Changer
by Mark Kiesel of PIMCO,
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.
PIMCO
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.
Rethinking Risk: Pension Plans Should Adjust to Global Realities
by Jeff Helsing of PIMCO,
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.
Something Old, Something New, Something Borrowed and Something 2
by Richard Clarida of PIMCO,
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.
From Argentina to Athens?
by Mohamed A. El-Erian of PIMCO,
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.
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. 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.
Inflation Outlook 2012: Benign, But Watch the Tails
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.
Notes from the CES: As Old Tech Tries to Stay Relevant, Investors Need to Be Careful
by Terrence L. Ing of PIMCO,
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.
Still Losing the War on Unemployment
by Mohamed A. El-Erian of PIMCO,
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.
Investment Opportunities in the Changing Cash and Short Duration Markets
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.
Life and Death Proposition
by Bill Gross of PIMCO,
When interest rates approach zero they may transition from historically stimulative to potentially destimulative/regressive influences. Recent central bank behavior, including that of the U.S. Fed, provides assurances that short/intermediate yields will not change, and therefore bond prices are not likely threatened on the downside. Most short to intermediate Treasury yields are dangerously close to the zero-bound which imply limited potential room, if any, for price appreciation. We can't put $100 trillion of credit in a system-wide mattress, but we can move in that direction by delevering.
Investment Management in the Age of Austerity
by Douglas Hodge of PIMCO,
The broader financial industry is in a state of contraction, and the primary drivers of investment management revenue have become less reliable.
Higher volatility and lower returns have fundamentally changed the relationship between investors and the managers to whom they entrust their wealth. We are all being held to a higher standard.
We believe those investment management firms that can adapt and absorb these profound changes will come out ahead and will be best prepared to deliver value to their clients.
To Fight or Not to Fight the Worlds Central Banks
We are skeptical that fiscal austerity alone is sufficient for all eurozone countries to grow and remain solvent. We thus expect the ECB to continue supporting the euro area with liquidity in 2012.
Recent central bank policy in China is oriented toward stabilizing growth in a political succession year, while balancing lingering inflation and medium-term systemic risks.
Investors may want to hedge portfolios by looking to select emerging markets with the ability and willingness to cut policy rates both from a cyclical as well as structural perspective.
Tide Turns for Structured Credit
Many investors remain skeptical, but the market environment for structured products has changed markedly since the financial crisis of 2008.
Current pricing now reflects a more realistic view of the underlying fundamentals, including weakness in the global economy and U.S. housing market.
We believe now is the time to consider entering the structured credit market.
TIPS for Financial Repression
by Mihir Worah of PIMCO,
Treasury Inflation-Protected Securities got a boost last week after the Fed extended the period of time it is likely to maintain unusually easy monetary policy and moved toward adopting a formal inflation target of 2% for the Personal Consumption Expenditure Index. Bernanke said that the central bank was likely to allow deviations from this target if employment was not where the Fed thinks it should be. We think financial repression is likely to persist and real interest rates are likely to be lower than recent history would suggest for the foreseeable future.
Questions and Answers About S&Ps European Downgrades
Sovereign downgrades will likely be another trigger for cuts in the ratings of European banks. Nearly all major eurozone banks are on negative watch.
Even those securities guaranteed by eurozone sovereigns that were not downgraded are also in the ratings agencies crosshairs.
The most significant downgrade for benchmark compositions was Portugal -- downgraded to below investment grade by S&P, consistent with Moodys and Fitch.
Riding the Global Roller Coaster: The Outlook for Emerging Markets High Yield Corporates in 2012
by Brigitte Posch of PIMCO,
Because many emerging market high yield companies were able to deleverage after the 2008/2009 crisis, we believe they are generally in a stronger position than their developed market counterparts.
Limited financing needs should provide technical support to the overall emerging markets corporate market.
In an environment where lending conditions tighten in international capital markets, domestic markets may become a source of funding for EM HY corporates.
Asia-Pacific Portfolio Managers Discuss PIMCOs Cyclical Outlook
We expect emerging Asia growth below the market consensus due to its less aggressive policy responses compared to 2008-2009.
The Asia-Pacific region is less affected than others by eurozone turmoil but contagion is still a risk through direct trade and the regional production chains that characterize Asias export-oriented economies.
In this environment, we favor Australian government bonds for their high credit quality, low-beta currencies such as the Chinese yuan, corporate issuers that have delevered, covered bonds and mortgage-backed securities.
Thinking About the Implications of Rising Euro-Exit Risks
by Myles Bradshaw of PIMCO,
Even if the euro survives this crisis intact, the market will price in uncertainty as the crisis evolves. Scenario planning is indispensable for investors.
Politics may prevent the European Central Bank from buying government bonds, but it could provide funding support via a special government or banking intermediary. This balance sheet expansion could be a negative for the euro.
Within the eurozone we believe investors should look at alternatives to the government sector, including agency, regional government and covered bonds.
The Mess That Is the Eurozone Inflation-Linked Bond Market
Italian ILBs now mostly reflect credit risk and tend to trade at a discount to compensate for the higher volatility. Unless the eurozone collectively decides to inflate their way out of their sovereign debt problems through a large increase in the ECB balance sheet, Italian inflation-linked bonds are likely to keep trading like a more volatile and less liquid version of nominal Italian bonds. A European investor looking to secure consumption of real assets in the future may wish to think about alternative measures to help protect their real purchasing power when hedging real liabilities.
Do Friday's European Downgrades Matter?
by Mohamed A. El-Erian of PIMCO,
Friday's downgrades of European sovereign ratings debt is all over the place-from those dismissing it as old news to those viewing it as part of a larger and consequential transformation of the international monetary system. What follows is an attempt to provide a guide to the multi-faceted implications. It focuses on three types of consequences: 1 those that are unambiguous and already reflected, albeit not fully, in market valuations. 2 those that are less well understood but will become clearer. 3 those that are consequential but where the analytics are still largely unknown at present.
Chaos Theory
by Neel Kashkari of PIMCO,
How developed nations address their fiscal deficits will have broad implications for equity markets. Debating a future of inflation vs. deflation is radically new territory for investors. The chaotic nature of the choice facing societies is whipsawing equity markets and dominating bottom-up factors. Equity investors seem to be pricing in a combination of outcomes, with the largest weighting going to a goldilocks, mild inflation scenario. But the markets large daily swings reflect jumps back and forth as investors update the probabilities of very different destinations.
Stock Volatility: Not What You Might Think
by Charles Lahr of PIMCO,
Contrary to finance theory, lower risk appears to produce the potential for higher returns over the long term.
Volatility tends to amplify stock returns so higher risk generally leads to higher returns in a positive market and greater losses in a negative market.
Over the long run, lower volatility stocks can lead to higher returns because avoiding the downside can have powerful effects on compounding.
Higher volatility stocks tend to fit the definition of speculative, while low volatility stocks can offer the potential for preservation of principal and a satisfactory risk-adjusted return.
Macro Matters: Incorporating Top-Down Views in Emerging Market Equities
From 2003 to 2011, over 50% of returns of the MSCI Emerging Markets Index came from country-related and currency-related factors.
Over the next 12 months, there will be elections in countries representing just under half of global GDP. Therefore, we expect more policy experimentation, varying degrees of effectiveness, and unintended consequences.
Currencies are also an important driver of EM equity returns, and the cost of hedging currencies has meaningfully declined over time.
Towards the Paranormal
by Bill Gross of PIMCO,
The New Normal, previously believed to be bell-shaped and thin-tailed in its depiction of growth probability and financial market outcomes, appears to be morphing into a world of fat-tailed, almost bimodal outcomes.
A new duality credit and zero-bound interest rate risk, characterizes the financial markets of 2012, offering the fat left-tailed possibility of unforeseen policy delevering or the fat right-tailed possibility of central bank inflationary expansion. Until the outcome becomes clear, investors should consider ways to hedge their bets.
PIMCOs Scott Mather Discusses the Global Implications of the Eurozone Crisis
by Scott A. Mather of PIMCO,
The ECB does not want to be a bridge to an unsustainable and adverse economic destination. They would rather force politicians to address the critical problems of the currency union now.
Greece will continue to have an unsustainable debt load until policymakers can come up with a credible plan to generate economic growth.
Ultimately, the eurozone countries and many other developed economies have very similar problems: unsustainably rising debt loads coupled with structurally weak and imbalanced growth.
Delayed LDI Implementation: Making it Worth Your While
by Rene Martel of PIMCO,
With interest rates so low, many defined benefit plan sponsors have delayed implementing or expanding LDI programs, often using intermediate duration bond portfolios instead.
Traditional intermediate duration portfolios may not offer the most attractive yields or the best credit match for pension liabilities, and may make the transition to long-term bonds difficult later.
We believe plan sponsors in a waiting mode should consider switching to long duration portfolios with a synthetic overlay in an effort to reduce duration exposure.
Hot Potato
The world is playing a game of hot potato with European financial assets, and the European Central Bank is a reluctant player. Together, Europes fiscal and monetary authorities can likely avert a systemic accident, but they must act quickly and courageously. Differentiation among emerging market monetary policies is increasing. And in Australia, the central bank will likely need to ease further in 2012. If every central bank enacts similar monetary policy tools, those tools compete for the same targets (financial and inflation stability), thereby potentially eroding their effectiveness.
The Three Rs of Investing
by Marc Seidner of PIMCO,
The inability to achieve sustainable levels of economic growth raises the risk of recession in many developed world economies. Under financial repression, market interest rates are kept very low for a very long time period with the hope of stimulating investment, but repression also starves savers to the benefit of borrowers. Increasing risk with an uncertain distribution of possible outcomes should lead to caution regarding traditional models and asset allocation practices.
Asset Allocation and Risk Management in a Bimodal World
by Vineer Bhansali of PIMCO,
Fat tails and negative skewness in the distribution curve can arise from the mere possibility of multiple equilibriaeven if both individually appear normal. Once markets arrive at a resting place among different equilibria, they tend to become trapped due to a variety of restraining forces. For all these reasons, we believe that the core building blocks of asset allocation and option pricing in the current macroeconomic environment should allow for the possibility of multimodality. This significantly changes the conceptual approach towards portfolio construction and risk management.
Rethinking Asset Allocation: PIMCOs Strategy for a Changing World
Alpha generation is a distinct component of the strategy because it is critical to actively seek opportunities in all global markets in this challenging environment.
Explicit tail risk hedging is essential to prepare for more frequent significant downturns, both to mitigate their effects and to potentially benefit from them.
The strategy is positioned to navigate a world of muted growth in the Western economies, significant market volatility, recurring balance sheet issues and continued income and wealth convergence of the emerging world with the developed world.
Neither a Quick nor Comprehensive European Fix
by Mohamed A. El-Erian of PIMCO,
European leaders still need to do a lot more, and quickly, if they are to catch up and get ahead of the crisis. Accordingly, and regrettably, the specter of volatility caused by European headlines will not recede for long. Investors need to continue to watch and worry about Europe.
Emerging Markets Bonds and Currencies in an Uncertain World
by Ignacio Sosa of PIMCO,
Even if global risk deteriorates significantly, emerging markets may continue to offer compelling risk-adjusted return characteristics. Emerging markets external sovereign debt, along with receiving interest rates in higher-quality EM countries, could be the best relative performers. EM currencies would likely sell off sharply in risk-off periods but would also tend to rebound robustly when risk appetite returns. Several Asian currencies are likely to be the best relative performers. Emerging markets assets remain a risk asset class and will not be immune to waves of global jitters.
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