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Preparing Portfolios for Recovery and Growth

PIMCO Group CIO Dan Ivascyn discusses why we see positive prospects for growth in 2021, and highlights areas we think stand to benefit as the global economy recovers.

Text on screen: PIMCO

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Text on screen: David Fisher, Head of Traditional Product Strategies

David Fisher: Hi, I’m David Fisher, head of Traditional Product Strategies here at PIMCO, and today I’m joined by Dan Ivascyn, our group CIO, to talk about PIMCO's outlook for 2021, and discuss how the Investment Committee is thinking about managing portfolios in this volatile economic environment. Thanks for joining us, Dan.

Dan Ivascyn: Thanks, David.

David Fisher: In the recent cyclical outlook, PIMCO has said that it expects growth to be significantly stronger in 2021. Could you talk a little bit more in detail about what our expectations are for the growth outlook this year?

Text on screen: Daniel J. Ivascyn, Group Chief Investment Officer

Dan Ivascyn: I would categorize our views towards 2021 growth as being a recovery year. It's going to be relatively challenging for many regions of the world as the COVID virus continues to have a significant negative impact on growth.

But we do expect as the vaccine on a global basis gains traction, particularly over the first couple of quarters of this year, that we can expect to see growth accelerate across most regions of the world.

Text on screen: As vaccine gains traction, global growth should accelerate
Image: Federal building with American flags

In the United States, for example, this year we could see growth rates above six percent. Even in Europe, although growth is currently more sluggish, we could see a meaningful recovery towards the second portion of the year.

Then across the Asia region where the virus has had less of an impact, or where many of these countries have had to deal with the virus far earlier than the US and Europe, were even more optimistic on the growth environment.  And I think that's what you’ve seen across many financial markets, discounting nearer-term uncertainty with some confidence that we're going to see meaningful growth later on in our investment horizon.

David Fisher: So given that fairly rosy outlook for growth, how is the Investment Committee thinking about the outlook for inflation in 2021?

Dan Ivascyn: We at PIMCO still believe that inflation's going to remain relatively well-bounded. We will see a cyclical uptick in inflation this year. But from a longer-term perspective, we still don’t see a meaningful risk of inflation breaking out significantly to the upside.

Text on screen: TITLE – Two Key Inflation Factors BULLETS – Demographics, Technological innovation

We still think for a lot of the reasons we've talked about for many, many years now like demographics, technological innovation, two key factors that will keep inflation relatively in check.     

David Fisher: So fiscal and monetary support, clearly two aspects of the outlook that would contribute to growth in 2021. On monetary policy specifically, is the view that rates should remain very low across the world? And secondarily, what is the IC thinking about the risk that has been talked about recently that central banks may—in a strong growth environment—think about tapering some of their bond purchases?

Dan Ivascyn: In general, we believe that most global central banks will remain quite accommodative. We think that rates are likely to remain low for many, many years, in fact, at least in terms of our base case thinking.

Now in terms of interest rates, although we think policy rates will remain anchored, near zero or even at negative type levels, longer maturity rates certainly can rise somewhat from here.

Image: Global central banks

 And we think that central banks may look at and assess economic growth later this year and begin to think about tapering some of their bond purchases.

However, we think they're going to be reluctant to taper too quickly. And it would be only in much higher growth scenarios with real signs of sustained inflationary pressure where we think that they'd taper sooner than the market currently anticipates.

David Fisher: So in 2020 I think one of the key response factors was a coordinated approach between monetary policy—you’ve talked a little bit about that—and fiscal policy, a very strong and powerfully coordinated approach. So both in the US and globally, what do you expect from fiscal authorities this year?

Dan Ivascyn: On a global basis, we think that the fiscal impulse will be weaker this year than it was in the midst of the crisis back in the first quarter of 2020. But we believe that most global policymakers remain very, very focused on this COVID-related shock to the overall economy. So from a fiscal perspective, again, if necessary we do believe there's a willingness to do more rather than do less.

Image: United States White House, US Capitol

In the United States, President Biden will be able to govern at least during the first couple of years with a democratically controlled congress, both house and senate.                        

But we don’t expect the same type of rampant spending, aggressive fiscal spending in the United States, that we would have gotten if we saw a more significant democratic sweep. Again looking at fiscal in other regions of the world, we think that the Europeans will continue to be on the accommodative side, particularly if necessary if their economies remain stuck in a very, very low growth or even negative growth environment.

In Asia, a little bit less prospect for stimulus, for many of the reasons that I mentioned earlier. So in summary, when we look at the backdrop for economies—and by extension, financial markets—we think policy support is going to continue to be quite significant. There'll be a lot of global liquidity out there targeting risk assets. And we think that that will continue at least in our base case to be quite supportive for markets, with that one exception being the China situation where policymakers are going to be focused on potential overheating in certain segments of the economy.

David Fisher: Let's turn to financial markets. In our Secular Outlook published in October, we predicted that bond yields are likely to remain range-bound for the next several years. Now earlier, you mentioned the possibility that interest rates may rise. Does this represent a change in view, or do we still expect interest rates to remain range-bound for the foreseeable future?

Dan Ivascyn: So from a longer-term perspective, because we don't see inflation as being a meaningful risk at least over the near-term,  

Text on screen: Long-term view: We expect rates to remain range-bound.
Image: Traders working at computers on the trade floor.

we expect rates to remain relatively range-bound. Now with that said, as we begin to see growth recover perhaps in an accelerating fashion, high-quality bond yields can certainly go higher from here. So when we think about 10-year Treasury yields, we think we can certainly see a 1.25%-1.5% 10-year as this recovery gains traction. But we think it's unlikely that yields are going to overshoot meaningfully higher from there.

David Fisher: So in terms of credit markets, clearly, significant fiscal and monetary intervention have helped to narrow credit spreads from the wides that we saw in March of last year. Now that said, in some sectors, particularly those hardest hit by the recession, spreads remain much wider than their pre-pandemic levels. So what are our views on credit markets, and where are we finding opportunities?

Dan Ivascyn: It's getting more challenging within credit markets. And we've seen pretty significant tightening across the more generic segments of the corporate credit opportunity set.

But there are some interesting opportunities within the credit space more broadly. One, there's a lot of special situations across the corporate investment opportunity set in both public and private markets.

Text on screen: TITLE – Opportunities in Credit Markets BULLETS – Gaming, Hospitality, Building materials, Leisure, Financial, Residential real estate, Emerging markets

Areas like gaming, hospitality, building materials, other sectors more directly hit, the leisure sectors is another example by COVID can continue to perform and perform well from a total return basis as economies recover towards the second half of 2021.

We still like the financial sector as another example. There you see relatively low risk-taking across most major financial institutions, but very attractive capital positions. We also continue to like the residential real estate segment of the opportunity set in the US, Europe, and some other developed markets.

And then segments of the emerging markets look attractive from a relative perspective as well. Many regions of the emerging markets—or segments of the emerging markets—have been significantly negatively impacted by this COVID situation and where their policymakers had less flexibility to support those economies. As we see more of a sustained global recovery, we would expect some of those emerging markets to continue to perform well also.

David Fisher: So you’ve talked a lot about opportunities in private credit since the pandemic in March. Is this an area where you still see opportunities for investors to take sort of long-term positions in these sort of more opportunistic and high-risk sectors? Are there still opportunities there for investors in 2021?

Dan Ivascyn: Absolutely. This is one of our highest conviction views. Although today yields are much, much lower than they were coming out of the last financial crisis—again, over a decade ago—the incremental yield advantage of private opportunities versus more generic public opportunities is as wide as they've ever been.

So the additional compensation that an investor gets by going down liquidity spectrum or up the complexity spectrum somewhat remains very, very wide. So these are areas that have been less influenced by policy, and these are areas where we could see considerable yield compression over the next couple of years. So if you have the ability to give up some liquidity to take advantage of these opportunities, we absolutely think it makes a lot of sense in a global context for nearly all investors.

David Fisher: Thanks, Dan, for joining us and sharing those views. And thanks to all of you as well for joining us.

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Please note that the following contains the opinions of the manager as of the date noted and may not have been updated to reflect real time market developments. The continued long term impact of COVID-19 on credit markets and global economic activity remains uncertain as events such as development of treatments, government actions, and other economic factors evolve.  All opinions are subject to change without notice.

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. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Sovereign securities are generally backed by the issuing government. Obligations of U.S. government agencies and authorities are supported by varying degrees, but are generally not backed by the full faith of the U.S. government. Portfolios that invest in such securities are not guaranteed and will fluctuate in value. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. U.S. agency mortgage-backed securities issued by Ginnie Mae (GNMA) are backed by the full faith and credit of the United States government. Securities issued by Freddie Mac (FHLMC) and Fannie Mae (FNMA) provide an agency guarantee of timely repayment of principal and interest but are not backed by the full faith and credit of the U.S. government. Diversification does not ensure against loss.

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