Journey Through Economic Times

Text on screen: PIMCO

Text on screen: PIMCO EDUCATION, Journey Through Economic Times with host Roger Nieves (8 minutes) PIMCO provides services to qualified institutions, financial intermediaries and institutional investors. This is not an offer to any person in any jurisdiction where unlawful or unauthorized.

Text on screen: Roger Nieves, Senior Advisor, PIMCO Advisor Education Team

Roger: Welcome to a Journey Through Economic Times. This presentation is not just about history, it is really about the human experience – and how the era that you live through can have a profound influence on your views as an investor.

Full page line chart; text on screen: TITLE – Forty years of falling interest rates; The chart, titled US Government 10-Year Treasury Yield %, shows the yield on the 10-year Treasury note from 1962 through 2020. From 1962 through roughly 1982, the yield rose steadily before falling steadily through 2020.

And let’s start with our favorite historical subject at PIMCO and that is bonds. This chart shows you the yield on the 10 year Treasury note going back to the early 60s. As you can see, interest rates are pretty low from a long run historical perspective. Not quite the low for the series, but close.

One question that investors are asking themselves is - are we finally at an inflection point? Is the long run picture with inflation and yields changing? History has a few lessons for us, as we think about the answer to that question.

Full page graphic: TITLE – Economic and political forces influence outcomes in the bond market; Sub-header -- Understanding history informs our perspective as investors. Three dark squares with rounded corners with text: Square 1 reads -- Politics (capitalism vs. socialism), Demographics, Geopolitical developments (wars, pandemics), Technology; Square 2 reads – Growth and Inflation; Square 3 reads – Bond market returns.

Here at PIMCO, we have observed that there are economic and political forces that drive change in the economy over time – for example a shift in the long running battle between free market capitalism and a more activist government – can lead to certain growth and inflation outcomes – and growth and inflation can drive the performance of the financial markets.

This is why as a bond market investor, it can make sense to take a step back from time to time, and make sure that we understand these secular forces.

Full page graphic: TITLE – Emergence of the Modern Age (1914–1929). Table -- Asset Allocation Implications; Stocks 13.12%; Bonds 4.84%; Gold n/a; Oil 6.43%; inflation 4.05%. Text under table: World War I (1914–1918); Emergence of public securities markets; Rise of capitalism, the entrepreneur and the merchant class; Mass production and the “power of productivity;” New York becomes the world’s financial capital.

Okay so let’s do just that, and let’s jump into our first era. And that is the Emergence of the Modern Age. 1914-1929. World War I and the Roaring 20s. It’s boom time. It is the era of the JP Morgans, and Rockefellers. Mass production raising living standards. Stocks did well. They returned over 13% annualized.

What did this first era teach us?

Full page graphic: TITLE – Lessons from the Emergence of the Modern Age; Two boxes with text, first box reads -- Entrepreneurship, capitalism, and the financial markets transformed the global economy; second box reads – Long-term investors benefited from ingenuity and investing in growing businesses through the stock market.

Well, we saw how entrepreneurship transformed the economy. We also saw how human behavior – or what economist John Maynard Keynes called animal spirits - can really drive the markets. We also learned that patience can be rewarded. Long term investors benefited by investing in growing businesses through the stock market.

But of course markets can ebb and flow. Next we go to the Great Depression and the New Deal Black Thursday: October 1929.

The Dow Jones Industrial Average sank 64% in three days. By 1933, more than 10,000 banks had failed.

Full page graphic: TITLE – Great Depression and The New Deal (1929–1941). Table -- Asset Allocation Implications; Stocks -6.44%; Bonds 4.24%; Gold 4.36%; Oil -1.69%; inflation -1.05%. Text under table: Market crash of 1929 – “Black Thursday;” Banking system collapses; Massive securities regulation; Roosevelt’s “New Deal;” World War II begins in 1939.

Here we see a major swing in the long running battle between free markets and government. The government responded here with ambitious regulation. 

In this era, bonds returned 4.2% annualized, not bad in comparison with the negative 6% annual returns in stocks from 1929 to 1941.

What did we learn in this era? Here too, we learned about investor psychology. It can be instructive to put ourselves in the shoes of those that lived through the losses of the Depression. Many of us have heard the stories of our grandparents, and great grandparents who grew up to be thrifty and resilient – and perhaps, a little skeptical of financial markets.

Full page graphic: TITLE – Lessons from the Great Depression and the New Deal; Two boxes with text, first box reads -- The government plays an important countercyclical role during a depression. It can offset weakness in the private sector; second box reads – Do not put all of your eggs in one basket; You need a mix of aggressive and conservative investments (like government bonds).

We learned that government spending can play an important countercyclical role during a depression. It can offset weakness in the private sector. In fact, you can argue that this Depression playbook is similar to what the government follows today when battling recessions or more recently, a pandemic. Importantly, we also learned during this era that you should not put all of your eggs in one basket. Investors need a mix of aggressive and conservative investments like government bonds.

Full page chart: TITLE – US Stock and Bond Correlation dating back to 1933; this chart shows the correlation between stocks and bonds going back to 1933. The blue line that measures the correlation of the asset classes begins slightly above the 0.0 line and moves up and down through the years, mainly staying between 0.5 and -0.5.

Here you see an illustration of that. This chart shows you correlation between stocks and bonds going back to 1933.Correlation is a statistic that measures how the prices of two assets move together.

Note how the prices of stocks and bonds do not always move together. In fact, the long term correlation between these two assets is fairly low – fluctuating around that zero line. And that highlights the power of diversification – which is still the closest thing to a free lunch that exists in the financial markets.

Full page graphic: TITLE -- The Great Inflation (1960-1980); Table -- Asset Allocation Implications; Stocks 7.62%; Bonds 5.15%; Gold 19.23%; Oil 17.54%; inflation 5.31%. Text under table: “Baby Boomers” seek jobs; Strong, consistent growth in 1950s and 1960s; Vietnam War; Deep recession and stagflation in the 1970s; Paul Volcker takes over the Federal Reserve and vows to slay the inflation “dragon.”

The next era in our preview is the “Great Inflation” leading up to 1980. This might be the type of inflationary environment that some investors are particularly worried about today. The government ran inflationary policy in the 1970s because we needed a growing labor market for Baby Boomers.

But external factors played a big role. OPEC imposed an embargo in 1973.  Energy prices spiked and a wage price spiral followed.

Some baby boomers and Gen X’ers out there might recall waiting in gas lines, and President Carter asking Americans to wear sweaters indoors.

Paul Volcker at the Fed ultimately hiked the Fed Funds rate to 20% in 1980 to break the back of that inflation.

In this environment, real assets like oil and gold generated annualized returns in the high teens.

Full page graphic: TITLE – Lessons from the Great Inflation; Three boxes with text, first box reads -- Demographic change, like the emergence of Baby Boomers, can affect the economy and the financial markets (look to Japan for a more recent example); second box reads – Political leadership was required to address economic issues like inflation, and geopolitical conflicts like the Cold War; third box reads – Real assets like real estate, commodities, and gold can outperform in inflationary scenarios.

What did this era teach us? A couple of things:

We learned that demographic change, like the emergence of Baby Boomers, can really affect the economy and the financial markets.

We learned that political leadership can be required to address tough issues like inflation and geopolitical conflicts.

Lastly we learned that real assets like real estate, commodities, and gold outperformed in this inflationary scenario. A consideration for those that are worried about inflationary overshoots in the years ahead.

Full page graphic: TITLE – Investment returns over the eras; this table shows that stocks handily outperform bonds in most of the eight eras; bond returns were positive in each and every one of these eight eras, ranging from 1.6% at the low end to 9.8% at the high end; Inflation was in the -1.05% --5.31% range across the eras, and gold fluctuated from a low of -2.77% to a high of 19.23%.

One of the fun parts about studying these different eras is seeing how different asset classes have performed over the decades. As you can see here, and as we would expect, stocks handily outperform bonds in most of the eight eras that we examine in our full presentation.

But perhaps interesting for us in this Bond Boot camp program is the fact that bond returns were positive in each and every one of these eight eras – including periods with low inflation and high inflation. Bond returns ranged from 1.6% at the low end to 9.8% at the high end. This is a fact that investors sometimes forget.

No one has a crystal ball. But one of the lessons of history seems to be

Full page chart: TITLE – US Stock and Bond Correlation dating back to 1933; this chart shows the correlation between stocks and bonds going back to 1933. The blue line that measures the correlation of the asset classes begins slightly above the 0.0 line and moves up and down through the years, mainly staying between 0.5 and -0.5.

that if you build a diversified portfolio with stocks, bonds and real assets like commodities, you will likely be better prepared to navigate different economic environments, political regimes, and inflationary scenarios.

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Disclosure

U.S. Federal Reserve (Fed)

The past performance of the assets classes discussed herein is no indication of their future results.

Asset class proxy data: *Stocks are represented by the Dow Jones Industrial Average, without dividends reinvested. The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 actively traded blue chip stocks, primarily industrials, but including financials and other service-oriented companies. The components, which change from time to time, represent between 15% and 20% of the market value of NYSE stocks. ** Bonds are represented by the Bloomberg Barclays Intermediate Government Bond Index (formerly the Lehman Brothers Intermediate Government Bond Index). The Bloomberg Barclays Intermediate Government Bond Index is an unmanaged market-weighted index generally representative of all public obligations of the U.S. Government, its agencies and instrumentalities, having maturities of up to ten years. ***Historical data for oil and gold prices are spot rates provided by Ibbotson and PIMCO. The spot price or spot rate of a commodity, a security or a currency is the price that is quoted for immediate (spot) settlement (payment and delivery). Spot settlement is normally one or two business days from trade date. ****Inflation represented by Consumer Price Index All Urban Consumers (CPI-U) U.S. city average all items. The Consumer Price Index is a measure of the average change over time in the prices paid by urban consumers for a market basket of consumer goods and services. It is not possible to invest directly in an unmanaged index.

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. Commodities contain heightened risk, including market, political, regulatory and natural conditions, and may not be appropriate for all investors. Equities may decline in value due to both real and perceived general market, economic and industry conditions. 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. 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. Inflation-linked bonds (ILBs) issued by a government are fixed income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Treasury Inflation-Protected Securities (TIPS) are ILBs issued by the U.S. government. Diversification does not ensure against loss.

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 long-term, especially during periods of downturn in the market. No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those shown.

The correlation of various indexes or securities against one another or against inflation is based upon data over a certain time period. These correlations may vary substantially in the future or over different time periods that can result in greater volatility.

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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