Text on screen: PIMCO
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Text on screen: Kimberley Stafford, Global Head of Product Strategy
Kim: What does resilience really mean for investors at this moment, and why should investors be paying attention to bonds today?
Dan: I think the bottom line is from a fixed income investor perspective, tremendous starting value, very exciting value. And value not just here in the US market, value all around the globe. And again, in this environment of much more extreme uncertainty, we do think investors need to use a slightly different playbook than what's worked in the past.
Text on screen: Daniel J. Ivascyn, Group Chief Investment Officer
Dan: There's a lot of conflicting forces at work. What may be inflationary today could be quite disinflationary over even the intermediate term. So, I think, again, investors should
Text on screen: Focus on high-quality income generation
focus on current high-quality income generation. Acknowledge that if AI is going to be as productivity enhancing as people think. It's likely going to be quite disruptive for certain business models, for certain companies, for certain regions of the world, for certain income cohort groups, and to focus on good, old-fashioned quality, global diversification to drive returns, but with a cautious eye towards disruption.
Kim: How do we price geopolitical risk as it's moved from what was episodic to more persistent?
Rich: We’re in a very, very elevated period now and likely for the next 5-10 years. Geopolitics, elevated geopolitical uncertainty, uncertainty which became kinetic conflict this year, and really the global race to protect economic security,
Images on screen: Data centers, mining operations, offshore drillingnot just AI and technology but critical minerals, and, obviously, choke points for energy supply are really going to be a structural feature of the global landscape. Active management in this sort of environment will be key because country and sector and company selection, bottoms up and macro, will be a big driver of performance.
Kim: Why does that give you a lot of confidence in the forward outlook for fixed income?
Dan: I think the most important point from an investment perspective is given the starting point for yields, given the fact that when you look at investments that protect against inflation, like a TIP, as an example, they're priced at a level where assume breakeven inflation rates or assume inflation rates remain quite low.
So, you don't need central banks to be as responsible as they've been in the past. And this is the concept of the cushion. We have very attractive valuations in both nominal bonds and in the inflation-protected segments of the market within fixed income and elsewhere. So, although we're constructive from a tactical perspective, the yield is going to do the heavy lifting over the next few years.
Text on screen: Build diversified high-quality portfolios at yields not seen in decades
Images on screen: PIMCO Trade floor
And you can construct portfolios in the high-quality space on a diversified basis at levels that we haven't seen in actually a couple of decades.
Kim: We estimate roughly $14 trillion in incremental global CAPEX over the next five years, with AI infrastructure around $7.6 trillion. As we expect a wave of CAPEX of this scale, how is this influencing how we would construct portfolios?
I think it's pretty clear that this AI wave that we're experiencing is just creating fatter tails. We've seen it in the past during the internet investment cycle, so this very well could lead to more equity volatility and perhaps a meaningful repricing of equities over a cyclical horizon, especially given starting valuations.
This relates to what I mentioned earlier about how the playbook likely needs to change in terms of generating strong risk adjusted returns on a go-forward basis. And that is the simple fact that the more productivity enhancing this technology is, the more disruptive it's going to be to existing business models. This is going to lead to a lot more volatility of returns. And this is what we're getting at to when we're talking about this idea that the credit cycle has begun.
Kim: How can investors source resilient sources of return in this environment?
Dan: Investors should be very, very focused on going out there and seeking diversification, not just from the perspective that diversification reduces portfolio volatility, but within the fixed income opportunity set today, it's a very unique environment in that you can
Text on screen: Pick-up yield and diversification
pick up incremental yield and diversification benefit. So, the global opportunity set should include bonds outside the United States in different currencies.
Text on screen: Less crowded emerging markets deliver attractive credit diversification
Images on screen: South Africa, Brazil
Emerging markets, an area that's less crowded than many areas of the credit markets are for very, very attractive diversification benefits.
So that's what we're illustrating is this idea that you can build off of an attractive yield, add incremental spread by widening out the global opportunity set, and then getting creative with tactical trading strategies along the way. We have even higher conviction that given the starting points for valuation today and extreme uncertainty, that this is going to be the way to generate equity-like returns with much less downside risk in a world of uncertainty, but also great global opportunity.
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Disclosure
All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Diversification does not ensure against loss.
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 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.
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