By Joachim Fels and Andrew Balls
It’s easy to get lulled into complacency by synchronized global growth, easy financial conditions and super-low economic and financial market volatility. Yet, while the current macro environment and outlook appear better than many of the younger market participants can remember, the last time a similar combination prevailed was in 2006 – and that didn’t end well.
However, then as now, when the macroeconomic environment is as good as it gets and valuations are tight, it is time to emphasize caution, capital preservation and diversified sources of carry away from the crowded trades.
Feeding the bull?
our baseline economic forecast is for a continuation of synchronized world real GDP growth at a decent 3% pace in 2018 (the same as this year), low near-term recession risks, a moderate pickup in underlying inflation in the advanced economies, mildly supportive fiscal policies and an only gradual removal of monetary accommodation.
Also, political risks emanating from nationalist/populist movements look more contained for now, particularly in Europe, partly as a function of better economic growth.
Moreover, China may well be successful in continuing to suppress volatility well beyond the 19th National Party Congress in October.
The ABCs of caution
However, once you start to look through the smooth macro surface at the underlying risks and uncertainties, there are a few problems that might pop up even over the short-term cyclical horizon and upset the eerie calm in financial markets.
Apart from the obvious geopolitical threat emanating from North Korea, the most important macro uncertainties – “the ABCs of caution” – are the aging U.S. economic expansion, the coming end of central bank balance sheet expansion, and China’s political and economic course following the party congress.
In the current market environment, we will emphasize capital preservation in our portfolios. We think it makes sense to emphasize portfolio liquidity and to avoid less liquid positions as a rule and focus on those bottom-up opportunities where we are truly paid for the risk.
While staying fairly close to home in the overall positioning versus the benchmark, we can aim to generate above-market return from a range of positions:
- U.S. non-agency mortgages
- U.S. agency mortgages
- Other select structured product opportunities
- Curve positioning
- Instrument selection
- Bottom-up credit positions
- Emerging markets (EM) foreign exchange positions
- EM local rate and external bond positions
- Optimization of bottom-up positioning with a high quality/income-focused bias more generally across specialist sectors
We expect to be slightly underweight duration overall, anticipating fairly range-bound markets but with the potential for a shift higher in yield across market levels that are low even in the context of our New Normal/New Neutral framework.
To find out more, please read PIMCOs Cyclical Outlook: As Good as It Gets.
Joachim Fels is PIMCO’s global economic advisor, a member of the Investment Committee and leads PIMCO's quarterly Cyclical Forum process. Andrew Balls is PIMCO's CIO Global Fixed Income, a member of the Investment Committee and oversees the firm’s European, Asia-Pacific, emerging markets and global specialist investment teams.
All investments contain risk and may lose value. Statements with regard to trends on financial markets are being made on the basis of the current market situation, which is constantly evolving. There is no guarantee that the afore mentioned scenarios will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market.
This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only. Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.
PIMCO provides services only to qualified institutions and investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized. |PIMCO Europe Ltd (Company No. 2604517) and PIMCO Europe Ltd - Italy (Company No. 07533910969) are authorised and regulated by the Financial Conduct Authority (25 The North Colonnade, Canary Wharf, London E14 5HS) in the UK. The Italy branch is additionally regulated by the Commissione Nazionale per le Società e la Borsa (CONSOB) in accordance with Article 27 of the Italian Consolidated Financial Act. PIMCO Europe Ltd services are available only to professional clients as defined in the Financial Conduct Authority’s Handbook and are not available to individual investors, who should not rely on this communication. |No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2017, PIMCO.