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Economic and Market Commentary

Asset Allocation Strategy: Risk-Off, Yield-On

Against a challenging macroeconomic backdrop, markets may be moving away from a world where equities rule – into one where high quality bonds are relatively more attractive.

Text on screen: PIMCO

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Text on screen: Jason Odom, Product Strategist, Asset Allocation

Jason: Hi, I’m Jason Odom and I’m joined by portfolio managers Erin Browne and Emmanuel Sharef to discuss PIMCO’s recently published our asset allocation outlook titled, Risk-Off, Yield-On. Thank you both for joining us today.

Erin, starting with you. Can you talk about PIMCO’s outlook and the investment implications for multi-asset portfolios?

Text on screen: Erin Browne, Portfolio Manager, Asset Allocation

Erin: Sure, thanks Jason. As we look out over the cyclical horizon, the macro picture is being challenged by 3 factors:

Text on screen: TITLE – Three challenges we see over the cyclical horizon: BULLETS – High inflation, Tightening financial conditions, Slowing growth

The first is high inflation, which we anticipate will remain elevated and above Central Bank inflation targets over the next year and it is going to limit the ability of Central Banks to cut rates in a recession.

The second is financial conditions tightening, the lagged impacts of which we’re going to continue to feel throughout 2023.

The third is slowing growth, and we expect that a recession is more likely than not over the next year across the US, the UK and Europe.

The investment implications of this view is that we are cautious and specifically underweight equities given our expectation that corporate profits and operating leverage will come under pressure in a recession.  Within equities, we are avoiding cyclical sectors, and overweighting quality. 

That said, we are starting to see compelling opportunities across fixed income markets which we’re really excited about given the current starting level of yields.

Text on screen: Fixed income an increasingly appealing alternative to equities

Images on screen: PIMCO trade floor

Markets are moving away from a world where there is no alternative to equities to one in which fixed income is increasingly appealing, and we expect this to be a large investment theme within our asset allocation portfolios next year.

Jason: Thanks Erin. What signal are you waiting for in order to become more constructive on equities and other risk assets?

Erin: In order for risk assets to stabilize, we first need to see stability in core assets and the risk free rate.  This is a necessary but insufficient condition to getting longer equities. 

Text on screen: TITLE – Market signals necessary for re-engaging with risk assets: BULLETS – Inflation to peak and decline, Rate stabilization, Re-rating of earnings expectations

For this, we need to see:

Convincing evidence inflation has peaked, as well as more certainty around path of rates.

Once we have seen core assets stabilize, the next condition that must be met is downward revisions to corporate earnings guidance, which remain too high and have not yet acknowledged deteriorating fundamentals.

Jason: Emmanuel turning to you. Rising rates and high inflation have been a major headwind for fixed income this year. What are your views on this asset class looking forward?

Text on screen: Emmanuel S. Sharef, Portfolio Manager, Asset Allocation

Emmanuel: So fixed income is in a very different situation than equities. First of all, in fixed income, starting yield is a pretty good predictor for forward-looking return, and yields have already risen tremendously, to the highest in decades. Second, if you think about credit spreads in terms of implied default rates, the market is currently pricing in a pretty draconian recession scenario in credit, unlike equities.

So fixed income we think does look quite attractive here in risk adjusted yield terms. That said, if we do head into a recession,

Text on screen: Focusing on high-quality, securitized fixed income

Images on screen: PIMCO trade floor

that could still hurt the weakest credit issuers, so we really want to focus on high-quality names, and on securitized products that have resilient cashflows.

Jason: And with a potential recession around the corner, how can investors protect their portfolios?

Emmanuel: We have spent a lot of time analyzing asset class behavior around the business cycle to just understand how portfolios should be positioned as the cycle shifts. In past recessions, credit has usually been the first asset class to underperform, and we’ve already seen that start to happen. But once recessions start to deepen, that's when usually there's more weakness in equities and strength in duration, meaning negative stock-bond correlation as investors start fleeing towards higher-quality assets.

Text on screen: TITLE – How investors can potentially protect their portfolios during a recession: BULLETS – Focus on high quality duration, Focus on companies with strong balance sheets

So even though this cycle has been extraordinary in many ways, we think that in a recession high quality duration can start protecting multi-asset portfolios again, and this cyclical can be more typical. The other key is to focus on quality across all asset classes, because companies with strong balance sheets and steady cashflows are the ones that are most resilient in downturns.

Jason: Erin, it has been an incredibly turbulent year in financial markets, with most assets on track to deliver negative returns. As you look out to 2023, what do you expect for financial markets?

Erin: As you noted Jason, 2022 was unlike anything that we’ve seen in financial markets in several decades. Core bonds and equities have seen double digit declines, resulting in an environment where there’s really “nowhere to hide” for multi-asset portfolios.   

Volatility is likely to continue, so it’s important to remain patient so that there is really room to capitalize on dislocations throughout the next business cycle.

Text on screen: Attractive opportunities are emerging in the medium to long-term horizon

Images on screen: PIMCO trade floor

That said, attractive opportunities are emerging, especially for investors with a medium to long-term horizon. The higher starting yields across fixed income have increased long-term return potential. We expect that higher-quality bonds will resume their role as reliable diversifiers against equities in a recession and this is offering attractive opportunities for asset allocation portfolios in the year ahead.

Text on screen: For more insights and information, visit

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The "risk-free" rate can be considered the return on an investment that, in theory, carries no risk. Therefore, it is implied that any additional risk should be rewarded with additional return. All investments contain risk and may lose value.


Past performance is not a guarantee or a reliable indicator of future results.

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. The credit quality of a particular security or group of securities does not ensure the stability or safety of an overall portfolio. Diversification does not ensure against loss.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are appropriate for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision. Outlook and strategies are subject to change without notice.

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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