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Positioning for a Growth Rebound

Group CIO Dan Ivascyn discusses how to position portfolios for a strong resurgence in economic growth while defending against elevated inflationary and interest rate risks – including the potential for future tapering-related volatility.

PIMCO Opener

Text on screen: PIMCO

Ribbon Graphic ID: DAVID FISHER, Head of Traditional Product Strategies

Text on screen: David Fisher, head of traditional product strategies

Fisher: Hi, I’m David Fisher, and I’m here once again with PIMCO’s group CIO Dan Ivascyn to talk about some of the recent conversations taking place in PIMCO’s investment committee or IC. Thanks for joining us, Dan.

Ivascyn: Thanks, David.

Fisher: So Dan, PIMCO is forecasting a strong recovery in global economic growth, and investors of course are looking for ways to take advantage of this growth. But the increase in asset prices has left valuations in many cases quite full, so how is the IC thinking about the opportunities and risks for investors in this environment?

Ribbon Graphic ID: DANIEL J. IVASCYN, Group Chief Investment Officer

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

Ivascyn: Sure, so you’re absolutely right, David. We do anticipate a pretty powerful growth recovery later this year. Our outlook’s predicated on continued success against the COVID virus, which will mean more efficient vaccine dissemination across further regions of the globe.

Chevron Split Screen – Text on left: Strong global recovery in the second half of 2021, B-roll on right: NYSE, Global markets

Text on screen: Strong global recovery in the second half of 2021

Images on screen: NY Stock exchange, global markets

So that’s a pretty positive setup for markets, but as you’ve mentioned, a lot of this has been priced into significant portions of the overall opportunity set. There’s been massive central bank policy accommodation, financial conditions remain quite loose, and for that reason, we’ve seen a lot of the yield oriented segments of the market rally quite significantly over the last 12 months.

So although we remain optimistic on the growth picture, we do think it’s time to begin to take some chips off the table, particularly in some of those sectors that have led the recovery, more generic forms of investment grade credit, high yield credit as examples, and beginning to concentrate more on some of the cyclical sectors which will benefit from this growth resurgence and some sectors of the market that will benefit more specifically from this COVID related recovery.

B-roll: Gaming, Leisure, Travel

Image on screen: Gaming, leisure and travel

Gaming sectors, leisure sectors. Sectors that tend to benefit from a pickup in global travel.

On the flipside, we’ve also tended to focus more on defensive segments of the opportunity set, areas of the market that had very strong fundamentals leading into this period of volatility.

FULL PAGE LIST GRAPHIC – TITLE: Areas of opportunity, LIST: Global housing markets, Certain asset-backed securities, Select emerging markets

Text on screen: TITLE – Areas of opportunity; BULLETS – Global housing markets, certain asset-backed securities, select emerging markets

Global housing markets are an example of that. Certain structured product markets that are backed by hard assets continue to be areas where we think investors should be overweighting the yield oriented segment of their portfolio.

And finally, emerging markets look increasingly interesting to us. These are areas that, again, should benefit from a more synchronized global recovery if it occurs as we expect later this year and well into 2022.

Fisher: So interest rate exposure has actually become slightly less expensive, unlike many other assets recently, given the backup in treasury yields has created a potentially better entry point for taking interest rate risk. What’s the IC’s view on this in terms of interest rates and what are the implications for portfolio positioning?

Ivascyn: Sure, so I commented on our growth outlook. Let me make a few comments on inflation to help frame our outlook for higher quality bonds or interest rates in general. We do expect a resurgence in growth but also a pretty significant pickup in inflation, at least over the course of the next several months.

Chevron Split Screen – Text on left: Expect temporary inflation uptick to level off near central bank target rates, B-roll on right: Central banks

Text on screen: Expect temporary inflation uptick to level off near central bank target rates

Image on screen: Central banks

But we expect that pickup in inflation to be temporary, and we do think there will be a leveling off somewhere close to central bank target rates. So given at least a base case view that inflation will remain relatively under control, we’re beginning to see better value in higher quality segments of the bond market.

But again, when you look at high quality bond yields in a historical context, they still look a bit expensive, perhaps not surprisingly so, because we expect to see considerable central bank support. Our own central bank, the Federal Reserve, we anticipate to remain on hold now in terms of short policy rates as well as continuing to support high quality bonds out the yield curve through their quantitative easing program which we expect, again, to continue well into this year and likely into the beginning of next year as well

So we were fairly defensive regarding interest rate risk going into this year. After the more recent selloff, we’re becoming more neutral but still remain a bit more defensive in terms of overall positioning.

If we see interest rates continue to rise while we retain our core base case outlook for the growth and inflation environment, we would expect to begin to add back some of that high quality bond exposure that we’re currently a bit underweight in.

Fisher: So you mentioned PIMCO’s inflation forecast. So the baseline is that even though we see a short term increase in inflation, longer term, that remains contained. But I know the IC focuses a lot of its attention on the risks to the baseline scenario, so could you talk a little bit about upside and downside risks to this inflation forecast?

Ivascyn: So although our base case view is that inflation will remain well contained, there’s certainly near term risks to the upside.

FULL PAGE LIST GRAPHIC: TITLE – Potential upside inflation pressure, LIST – Fiscal stimulus, Supply-related factors, TITLE – Disinflationary forces, LIST – Technological innovation, Stretched asset valuations

Text on screen: TITLE – Potential upside inflation pressure; BULLETS -- Fiscal stimulus, Supply-related factors, TITLE – Disinflationary forces, BULLETS – Technological innovation, Stretched asset valuations

Clearly, potential upside pressure from ongoing and significant fiscal stimulus, some other supply related factors in the economy, but also, when you look over the long run, there’s also these powerful disinflationary forces that will exist as well.

Technological innovation is one. Also the fact that asset valuations are quite stretched, and the next economic slowdown, the next negative shock, very well could be accommodated by or lead to more pressure on financial market valuations which can be disinflationary in nature as well.

So longer term, we see pretty balanced inflationary risks, but over the short term, there is this risk of overshooting and again, the cost to protect against those types of scenarios for investors remains relatively low in a historical context, and we think in the context of a multiasset portfolio, it does make sense to source some protection against that type of risk scenario, at least in the current environment.

Fisher: So Dan, one of the things that you highlighted is that we expect central banks generally to remain on hold in terms of interest rate policy. What are the risks in terms of tapering? Clearly, that’s on investors’ minds. 2013, the taper tantrum created havoc in markets. What’s the risk today of tapering by one or more central banks around the globe?

Ivascyn: Sure, so we do expect the U.S. Federal Reserve to remain on hold in terms of interest rate policy for several quarters, even in the face of strong growth and inflation drifting above their current target.

And we do think that they will look to begin to taper some of their balance sheet purchases towards the very end of this year or early in 2022, and this could be a bit difficult for markets because this tapering will likely occur in an environment of very strong growth and at least temporary inflationary pressure.

we also think relative to a few years ago, central banks have learned their lesson. They’re going to be very careful to communicate carefully and clearly to markets and be very measured in any type of tapering programs that they embark on later this year and into 2022.

Fisher: So Dan, you’ve talked a little bit about where PIMCO sees investment opportunities. Could you talk a little bit about how PIMCO goes about finding those opportunities? In other words, talk a little bit to some of the aspects of PIMCO’s investment process that you think are particularly important in the current environment.

Ivascyn: So what we’re looking to do is to use the same type of processes to balance the top down thinking with good bottoms up analysis,

B-Roll: PIMCO trade floor

Image: PIMCO trade floor

but really trying to focus on flexibility, with increased flexibility, there’s a tremendous opportunity to potentially take advantage of higher returns for the same unit of risk.

One area in particular that looks quite attractive is being able to go down the liquidity spectrum. Over the course of the last 12 months, there’s been a massive policy response to this economic slowdown, and this policy response in many instances has involved the direct purchase of significant fixed income securities, traditional corporate bonds, mortgage bonds, treasury bonds.

So by giving up some liquidity, by expanding the opportunity set, investors can generate very attractive returns in certain private segments of the market and certain segments of the market that are more complex in nature, may provide very attractive risk adjusted returns.

So customization, flexibility, the ability to exchange liquidity for more robust and higher yield or return are very, very attractive at the moment and are areas of our investment process that we remain quite focused on.

Fisher: Great, thanks for all that, Dan. And thanks to all of you for joining us as well. We’ll see you next time.

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