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Economic and Market Commentary

Resilience Required: A Guide for Investors

With companies, governments and investors reaching for resilience, Group CIO Dan Ivascyn discusses the importance of active management, the impact of inflation, and opportunities within public and private credit, real estate, and housing.

Text on screen: PIMCO

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Text on screen: Kimberley Stafford, Global Head of Product Strategy

Kimberly Stafford: How can investors build resilience into portfolios? And just in practical terms, what does reaching for resilience mean for investors?

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

Dan Ivascyn: Sure, let me start very high level. Looking forward, we are a bit more constructive on returns. We have had a significant repricing in markets and

FULL PAGE GRAPHIC: TITLE – High quality fixed income offers stronger value than in the past decade. The line chart shows the yield, duration and yield/duration for the following three indexes vs.10-year U.S. Treasury Yields from 2012-2022: Bloomberg U.S. Aggregate Bond Index (yield 3.93%, duration 6.63 and yield/duration 0.60), Bloomberg Global Aggregate Bond Index (yield 3.09%, duration 7.78 and yield/duration 0.44) and Bloomberg U.S. Corporate Investment Grade Bond Index (yield 4.81, duration 7.72 and yield/duration 0.62). The charts shows that since bottoming out in 2020, the yields for all three indexes have risen higher than they have been in the last decade.

there will be a greater prospect for return across fixed income markets. With some of the increased capital investment shifting demographic trend, we do expect real interest rates over the longer term to be a bit higher than we grew accustomed to which means that even higher quality segments of the bond market will offer higher returns than what we grew accustomed to during much of the post GFC recovery period, which now is almost 15 years in duration.

We do think inflation will likely be elevated. We do believe that over time central banks will get inflation back under control, but under control will likely mean higher inflation rates than what we, again grew accustomed to for much of the last 10 to 15 year period.

Text on screen: TITLE – Investment considerations:, BULLETS – Fixed income will play an important role at higher yields, Value returning to higher quality areas of the market, Inflation protection remains relevant over the next five years

So what that argues for would be higher allocations to quality fixed income, less need to go down the credit spectrum the pickup incremental yield.

So this adjustment process will likely mean value returning to some high quality areas of the market. Investors that are uncomfortable with the greater volatility, not wanting as big an allocation to some of those most credit sensitive sectors of the market. Then also the area of inflation protection.

We do think over a five year or five plus year period sourcing inflation protection across portfolios will make a lot of sense as well. And that can be done directly in TIPS markets or other inflation protected areas of the fixed income markets. Also, when we look at commodities they appear to be quite underowned. They'll be a lot of volatility near term, but over a multi-year period, we do think it makes sense for investors to think about allocations in those areas.

Kimberley Stafford: Makes sense. Thank you. And look, maybe drilling down specifically to corporations and consumers. There's a lot of factors in the balance that could potentially lead to higher credit losses or even defaults given the risk that we see and given, like we talked about probably less likely policy support on the horizon. So what is our outlook for credit markets?

Dan Ivascyn: Well let’s start at a high level.

FULL PAGE GRAPHIC: TITLE – Companies and consumers face significant uncertainty amid macroeconomic challenges. The sub-title is, Global policymakers aiming to delicately adjust monetary policies – investors anticipate potential dislocations. The graphic shows a balance scale representing various factors that global policymakers consider when making decisions. The left scale is weighed down by the COVID-19 pandemic and future variants, rising input prices, supply chain and logistics bottlenecks, global policymakers moving ahead with rate hikes, and sanctions on the back of geopolitical conflict. The right scale shows strong consumer balance sheets, tight labor market, and that companies can access $1 trillion in the private credit market.

Recessionary risk is elevated. Anytime you have a higher risk of recession, you want to be very, very cautious about credit sensitive investments, but initial conditions are quite strong. Household balance sheets are strong, we're at or well beyond full employment. We don't see the same challenges in the banking sector. We don't see the same extreme imbalances or the maturity transformation or leverage on leverage that we've seen during prior cycles. So from that perspective, we're constructive. The big challenges we have at inflation problem not a growth problem. So you have policy makers tightening at a point in time where growth is already relatively low and it appears to be declining quite quickly. It's been a long time since there has been a recession without massive policy support, which means it doesn't have to be a crisis environment like the GFC or the COVID period.

We don't think it's time to jump into the higher risk segments of the market just yet, we think you should stay defensive, stay resilient until you get paid enough to take that more significant risk.

And then just in terms of corporate credit more specifically,

FULL PAGE GRAPHIC: TITLE – Unprecedented and growing issuance in credit assets demands an active approach. Two charts are shown. The first chart shows US Public Market Growth as measured by the dollar amount outstanding from 2000 to 2021. Investment-grade credit, which comprises the bulk of the US public market, has consistently grown in the last 21 years. High yield and bank loans take up much smaller market shares. The second chart shows US Private Market Growth as measured by the dollar amount outstanding from 2000 to 2021. It shows steady growth, which was most pronounced starting around 2015-2016 through 2021.

you have seen significant growth in some of the lower rated or private segments of the corporate credit market. You've also seen a resulting deterioration of fundamentals in certain areas of this market. So we do think on a relative basis those areas warrant caution, especially those areas within the private space that haven't repriced yet.

Where we would be the most cautious currently are areas that have tended to be slow to react. We think one of the most exciting opportunities on a go forward basis will be to have contingent capital, to prepare for opportunities in that space, just given how large those sectors have become. We think that will be a great opportunity for investors to supplement their more traditional allocations to fixed income, public equity or private equity.

 Then last but not least, I want to bring it back to

 Images on screen: Residential real estate

the housing market. Our core view is that even if the economy slows significantly, you can get some weakness in home prices. You can get some weaknesses weakness in home prices, in real terms. You could even have scenarios where home prices go down on a national basis. That doesn't have to be a major problem because this is a market today with very, very high quality borrowers, very little excess, very little building over the last decade relative to household formation.

 Images on screen: PIMCO trade floor

When you look at some of the areas around household credit, asset backed credit, mortgage credit, banking credit, or financial sector credit, that's where you see the type of resiliency in pretty attractive spread levels that we think will lead the charge over the next five years.

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