Preparing Portfolios for 2023: Consider the Strong Case for Bonds
Text on screen: PIMCO
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Text on screen: Ken Chambers, Product Strategist
Ken Chambers: To get us started, maybe you could talk a little bit about the macro backdrop. Where do we stand today and how do you and the investment committee view that evolving in calendar year 2023?
Dan Ivascyn: It's been a volatile year, a tough year.
Text on screen: Daniel J. Ivascyn, Group Chief Investment Officer
The good news is that we do believe that we're finally seeing some signs of stabilization in the one area that's caused the most uncertainty this year, and that's inflation.
Text on screen: We believe that inflation comes down in 2023
Images on screen: Gas station pumps, grocery store
Today at PIMCO, we think inflation comes down next year. And I think it's important to talk about now the relationship between inflation and economic growth.
We expect economic growth in the base case to be low, even tip into negative territory next year. The base case is a shallow recession, but what's critically important from a portfolio construction perspective is that anytime you are forecasting a shallow recession, you absolutely need to prepare portfolios for something far worse. The good news today,
Text on screen: Fixed income offers resiliency during an economic slowdown
Images on screen: PIMCO trade floor
is that there are a lot of areas within the fixed income opportunities set that represent resiliency even if you had a more protracted economic slowdown.
Ken Chambers: If you think about you and the investment committee and the different strategies, how are we viewing duration risk within those portfolios today?
Dan Ivascyn: Well, at a high level, there's good value back at bonds as I mentioned, and to even reinforce that further. Even if you are more concerned about inflation, you could buy inflation protected assets and generate an inflation adjusted yield or real yield that again is at levels that we haven't seen in many, many years.
Text on screen: Remaining defensive on interest rate exposure may still generate attractive returns
Images on screen: PIMCO trade floor
So, in a given strategy, you can continue to be a little bit defensive regarding interest rate exposure and still generate those attractive returns.
So, at the moment across PIMCO portfolios, we're more neutral towards duration, even across some portfolios a little bit defensive.
We have been more involved in the TIPS market over the course of the last few months. Because even if we're wrong, if the markets are wrong, wrong and inflation remains elevated, that's an asset that will reduce overall volatility in that environment.
Ken Chambers: What are our thoughts and views on non-US markets?
And what about the dollar views on other major currencies at this time?
Dan Ivascyn: Yeah, the dollar has been incredibly strong for a long time. And based on that strength, when you look at other currencies around the globe, they look quite attractive from a long-term valuation perspective.
Images on screen: Brazil, New Zealand, South Africa
We've had some exposure to some of the commodity exporting currencies that's been very, very helpful for strategies within our emerging market area; they've been positive. But we're increasingly looking at increasing slightly some of our non-dollar exposure across the complex based on attractive valuations in some cases, central banks that have been much more active in ahead of the curve relative to the Federal Reserve and other developed country central banks.
Images on screen: Central banks
And the fact that we believe that we're going to see a material slow down in Fed tightening next year, and therefore that very well could be a catalyst finally for non-dollar currencies beginning to outperform.
Ken Chambers: You've talked about flexibility and the need for flexibility in portfolio constructions and different types of mandates. Can you talk a bit about what flexibility looks like in those portfolios today?
Dan Ivascyn: You have a tremendous amount of volatility around the globe.
Text on screen: TITLE – Sources of volatility: BULLETS – Less synchronized business cycle, Ukraine/Russia war, COVID policy uncertainty in China, Inflation
Less synchronized business cycles, war in Europe, policy uncertainty in COVID in China, despite the fact we've mostly declared victory on COVID here, they're dealing with COVID and they're at a very different point of their economic cycle. Lots of variability in terms of inflation around the globe. This is a great environment to have a global opportunity set, a great environment to have significant flexibility.
So, we do think in the context of an overall asset allocation, clients should think about being as flexible as they can, either giving up some liquidity to take advantage of longer-term opportunities, or be willing to escape the so-called home bias, expand into new areas.
Text on screen: We believe flexibility is key to maximizing returns in a 3-5 year outlook
Images on screen: PIMCO trade floor
We do think that will likely be the optimal way of maximizing return, especially if you have a three-year, four-year, five-year type outlook.
We still live in an uncertain world. So don't be overly aggressive. Respect the fact that we're in a highly uncertain environment, have more of a defensive mindset, but also get back into markets if you left.
And there are plenty of scenarios that can lead to a powerful rally that clients may not want to miss.
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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. 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.
Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio.
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