Unlocking Alternatives: Macro Opportunities in Mid-Cycle Markets
Text on screen: PIMCO
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Text on screen: William Quinones, Senior Vice President, Product Strategist
William Quinones: Let’s start with base case views from our last cyclical forum where we summarized our economic outlook as peak pandemic, peak policy, and peak growth. Can you please provide an update on where we are relative to those views today?
Text on screen: Qi Wang, CIO Portfolio Implementation
Qi Wang:The three P’s, I think for the most part that view has played out and then has priced in the market accordingly. So the question is, from this point on where are the opportunities?
Text on screen: TITLE – Key considerations:, BULLETS - COVID-19 Delta variant, Fed tapering, Economic recovery in China
So for us, the focus are on three dimensions. One is the Delta Virus, whether it’s peaking or inflexing. And second whether the Fed is going to taper or not taper. And thirdly, clearly, China has been tightening and slowing down this year. And from here, whether the PBOC is going to start to ease, and is China’s economy going to recover?
William Quinones: So in the traditional macro playbook,
FULL PAGE GRAPHIC – Macro playbook. The line graph shows the business cycles and the macro opportunities in each: The line dips for Recovery, which is defined as post-recession characterized by cheap valuations/ high risk premiums with a risk premium extraction opportunity; the line rises as the cycle enters Expansion, which see growth improving but imbalanced risk premiums – with relative risk taking, e.g., long one asset class versus another; the line peaks in Late Cycle, which is characterized by fair- to rich-valuations/ low-risk premiums – with a tactical trading and relative value focus; the line dips again as it moves to Contraction which is stagflation, growth concentration and/or financial market disruptions – with short risk assets and long volatility (i.e., negative carry).
if we agree we are in the mid‑cycle stage, the focus would be more on directional positions to harvest those risk premiums. However, while the real economy may still be in that expansion, financial assets in many cases seem to reflect pricing more typical of “late cycle.”
So can you talk about how one positions broad and flexible portfolios in such a regime?
Qi Wang: I think there is—at least based on historical experience—there is a major disconnect in the market in terms of the mid-cycle expansion, but late cycle asset prices. Although I caveat that we don’t know whether it’s just the new normal,
Images on screen: Central banks
because there’s so much central bank liquidity. So the asset prices are potentially going to stay at these relatively rich levels by historical standard.
I think if there is a big economic shock, some elements of the traditional macros still apply. One can take advantage of the market dislocations to take concentrated directional positions. But for the most part, in the low volatility mid-cycle market, I think one really has to think about portfolio construction a lot more thoughtfully in terms of constructing a portfolio that can
Text on screen: TITLE – Focus on portfolios constructed for a variety of scenarios, BULLETS - Use global resources, Focus on relative value within and across asset classes, Balance between long convexity and risk premium harvesting strategies
perform under a variety of scenarios and really use the global resources and then do both directional and the relative value strategies in single asset and across assets, and then thinking about long convexity positions balanced by risk premium harvesting strategies.
William Quinones: So can I ask you to describe areas of your current focus and opportunity? Where are you and the team spending the most time right now?
Qi Wang: We always look at a lot of things. We look at global markets. As you know, we have a big team.
Text on screen: Areas of potential opportunity: 1. Developed market interest rates
Images on screen: The Federal Reserve
But for now, most of the focus is developed market interest rates. And the volatility in the market is pretty low, so we want to use the market opportunity to construct positive convexity positions that give us exposure to higher interest rates in the market.
Last year we took advantage of the market dislocation to get long mortgages against different types of interest rate hedges.
Text on screen: Areas of potential opportunity: 2. Agency mortgage-backed securities
Images on screen: Commercial real estate
And then this March and April, we flattened out the position as mortgages reached to historically rich levels. And if the Fed is going to taper, we think the mortgages are going to start to widen from historically rich levels.
And thirdly in corporate credits, in partnership with our global credit team,
Text on screen: Areas of potential opportunity: 3. Select corporate credit
Images on screen: Retail shopping complex, hotel, and windmills
selectively we are adding exposure in potentially COVID recovery sector and also some corporate credit names that we think can benefit from secular disruption and some sustainability ESG initiative. And in mid-cycle when volatility is low, one should focus on systematic strategies as well. Try to harvest some short-term market dislocation and the risk premium. And that is in partnership with our analytics and quantitative team.
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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. The views expressed are as of the date recorded, and may not reflect recent market developments.
US Federal Reserve (The Fed); People’s Bank of China (PBOC).
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