A “new normal” will reign in investment markets after the shocks of last year, according to PIMCO, with the manager’s secular outlook favouring investment at the front-end of the yield curve as well as income producing instruments. This article looks at the outcomes of its recent secular forum including a call for investment management vehicles to be made more responsive and robust.
PIMCO’s secular forum, attended by investment professionals globally, guides the way it structures portfolios in terms of duration, yield curve position, sector exposure and credit quality. It is the manager’s belief that secular economic, political and social trends exert the most influence on bond markets. After its most recent meeting that outlook will be a journey of stops, starts and volatility.
The forum, attended by global PIMCO staff as well as external participants including former Federal Reserve chairman, Alan Greenspan, and Nobel laureate in Economics, Mike Spence, concluded that the next three to five years will be characterised by slow growth in developed economies, with emerging economies to bifurcate, short term deflation and long term inflation, and US dollar risk.
As a result PIMCO, which manages $756 billion in assets, says an environment of low growth and political uncertainty favours high-quality, yield-oriented securities over those offering mainly capital gains.
In addition it says a focus on global securities, over US bonds, will yield benefits, and investors should look to protect themselves against a weaker US dollar.
According to CEO and Co-CIO Mohamed El-Elrain, in his summary of the conference posted on the PIMCO website, the world has changed in a manner that is unlikely to be reversed over the next few years.
“Put another way, markets are recovering from a shock that goes way, way beyond a cyclical flesh wound.
“It is not just about the major realignment of the financial system and the extent to which governments have intervened to offset market failures. And it goes beyond the massive increase in government deficits and
government debt in virtually every systemically important country in the world (at a time when few countries can credibly pre-commit to the type of fiscal primary surplus required to subsequently reverse the massive deterioration in the debt dynamics),” he says.
“It’s also about the structural change in how savings are mobilized and allocated, nationally and across borders. It is about the shifting balance between the public and private sectors. And we should not forget the potentially long-lasting consequences of the erosion of trust in such basic parameters of a market system as the sanctity of contracts and
property rights, the rule of law, and the robustness of the capital structure. Such trust can be lost quickly but takes a long time to restore.”
The PIMCO dubbed “new normal” is increasingly resonating in policy circles and among market practitioners, reflecting a growing realisation that some of the changes to markets, households, institutions, and government policies are unlikely to be reversed in the next few years, El-Elrain says.
“Markets will revert to a mean, but it will not look anything like that of recent years. Relative to where it is coming from, the financial system will be de-levered, de-globalised, and re-regulated. Global growth will be lower and unemployment higher, notwithstanding the continued rotation of dynamism away from industrial countries and toward emerging economies. Price formation in many markets will be influenced by the legacy and, in some cases, continuation of direct government involvement. Burden sharing will feature more prominently, being one feature of the heavier hand of government in economic life,” he says.
“For a financial industry known for its famously short memory (and related infrastructures and behaviour), this will feel like a new normal. Adaptations will be needed as the configuration of risks and returns shift, government debt balloons, and capital structures potentially migrate toward a simplified structure consisting just of equity and senior debt instruments. Business models will need to be retooled, and investment management vehicles made more responsive and robust.”
