PIMCO Secular Outlook: Yield Advantage
17 JUN, 2024
By PIMCO
PIMCO, one of the world's largest fund managers, with $1.9 billions in assets under management, has shared its economic outlook, risks and investment opportunities report. Dan Ivascyn, Group Chief Investment Officer; Richard Clarida, Global Economic Advisor; and Andrew Balls, Chief Investment Officer for Global Fixed Income, share the Secular Outlook.
The three major keys whose risks may be being overlooked:
The global economy continues to recover from the aftershocks of the pandemic, including trade shocks, outsized monetary and fiscal interventions, a prolonged rise in inflation and bouts of severe volatility in financial markets. At PIMCO's Secular Forum 2024, we look at how the aftermath of these shocks is producing some unexpectedly positive developments, while introducing longer-term risks.
Among the positives, disinflation has occurred faster than expected in most developed market economies. Moreover, macroeconomic and inflation risks appear more balanced than in our previous Secular Forum a year ago. Central banks are also poised to pivot towards rate cuts, probably on different timetables.
We see three main areas where investors have benefited, but may be overlooking risks that could develop over our five-year secular horizon:
- Large-scale fiscal stimulus has driven recent outstanding US growth, but such exceptionalism has come at a cost: the US is on an unsustainable debt trajectory that the government will ultimately have to address. In the meantime, financial markets may increasingly have to operate without waiting for government support.
- Artificial intelligence (AI) is poised to realign labour markets and boost productivity, but significant economic impacts may take years. Massive capital investment has accompanied rapid stock market gains in ways reminiscent of technological booms of the past.
- Asset valuations in some markets offer investors little apparent cushion. This includes equities, where valuations appear stretched, and lower rated corporate direct lending markets, which are less liquid and more exposed to floating interest rates.
The six circumstances that have changed the global landscape in the last year
Our 2023 secular thesis argued that the disruptions of the early 2020s would create an enduring new reality. We saw a world of high macroeconomic volatility and slow growth. We predicted that central banks would do whatever it took to bring inflation back to a "2 point plus" rate.
While this thesis remains broadly valid, our outlook for the next five years must incorporate and assess the main developments since our May 2023 forum:
- A war raging in the Middle East and a war in Europe dragging into its third year.
- Rapid and, so far, painless disinflation at a rate of "2 and a bit points" in most developed market economies.
- Significant divergence of inflation and growth trajectories between the US and other developed country economies.
- An unforeseen doubling of the US budget deficit in an economy with near-record unemployment.
- An October "Treasury tantrum" triggered by concerns that the unsustainable US fiscal trajectory will worsen in the years ahead.
- Continued bank retrenchment amid tightening capital and liquidity regulations
Our Secular Outlook 2024 favours a renewed focus on public fixed income markets
- They offer attractive income potential, downside resilience and stability through lower correlation to equities.
- The traditional paradigm of 60% equities and 40% bonds: We believe we are entering an era that warrants a rethink and reversal of that concept.
- By identifying attractive opportunities in high quality areas, such as agency mortgage-backed securities, active managers can currently construct portfolios with a 6% to 7% return without taking on significant interest rate, credit or illiquidity risk.
- A diversified fixed income allocation offers the potential for equity-like returns over the long term with a more favourable risk adjusted profile, especially given what can be high valuations in equity markets.
- We currently find value in the 5 year part of the yield curve and are wary of potential long term underperformance due to tax concerns.
- Global bond markets offer particularly attractive and diverse opportunities.
- Global yields in both developed and emerging markets have returned to attractive levels. Many economies outside the US face greater fragility, but enjoy better initial fiscal conditions, both of which are favourable for bonds.
- Given the potential volatility around inflation, US Treasury inflation-protected securities (TIPS), commodities and real assets offer inflation-hedging properties and higher real rates than pre-pandemic levels.
- The growth of credit markets, both public and private, should offer more opportunities for active investors.
- We expect more regulation for banks, which should lead to more disintermediation and more money flowing through private markets.
- Asset-based lending is an excellent example of what we see as an attractive and less crowded investment opportunity. Middle market corporate lending appears to be in favour of private markets, but we believe areas such as consumer lending offer excellent fundamentals and long term value, as US household leverage has declined and housing markets remain well supported.
