Mihir Worah, CIO Asset Allocation and Real Return: Given the length of this business expansion and the volatility in Q4 of last year, a lot of investors are asking, are we at the end of the cycle?
Shots of PIMCO employees working.
And our analysis based on economic data, based on quantitative models, tell us that most likely we are in the late stages of this expansion, not at the end of this expansion. And this certainly has direct implications for investors.
Erin Browne, Portfolio Manager, Multi-Asset Strategies: Three key takeaways from the asset allocation outlook is to stay large, stay liquid, and stay defensive. As we move into an environment where volatility is going to pick up it's really important to take advantage of the higher volatility that we think is going to emerge, given where we are in the later stages of the economic business cycle.
Chart: An allocation dial shows overall risk weighting leaning slightly more toward under than over.
Geraldine Sundstrom, Portfolio Manager, Asset Allocation: Our overall risk stance is mildly underweight, but stay invested. We want to have a prudent stance, however not yet risk-averse.
The two overarching themes in our piece are quality and liquidity. Volatility is likely to rise in the coming quarters, and we want to maintain high quality in the asset we select, but also liquidity to have sufficient cash balances ready to take advantage of idiosyncratic opportunities in dislocated markets. So let's review each asset class.
Chart: An allocation dial shows overall equity weighting leaning slightly more toward under than over. The U.S., Europe, Japan and Emerging Markets are all mostly on par on the bar slide.
In the case of equities, we have a mildly underweight stance with a particular emphasis in two regions: the United States and Japan. This is where we find companies with better valuation but also higher quality, which is one of our key themes. We steer clear of Europe, which had challenging profitability even in good economic times, and now is facing a deep slowdown in the economic activity, as well as political uncertainties.
Chart: An allocation dial shows overall rates weighting leaning more toward under than over. The U.S., Europe, Japan and Emerging Markets are all mostly on par on the bar slide.
Mihir: In the government bonds or rates markets there's a high preference for U.S. treasuries. With ten-year treasuries around three percent you get a decent yield. On the other hand, there are government bonds we don't like, we think yields in the UK are too low because people are too concerned about a hard Brexit, and we think yields in Italy are too low as well given the budget dynamics in that country.
Chart: An allocation dials shows overall real assets weighting leaning more toward over than under. Inflation-linked bonds, commodities and MLPs are positive, gold is on par on the bar slide.
Turning to real assets, generally inflation tends to go up at the late stages in a cycle, so you wanna have an allocation to real assets, and we think inflation is one area where even though a base case is for modestly rising inflation in 2019, we think this is one tail risk that investors are underexposed to.
Chart: An allocation dials shows credit weighting leaning more toward under than over. Securitized is positive, high yield is negative, and investment grade and emerging markets are on par on the bar slide.
Erin: Credit tends to underperform as we move later within the business cycle. As a result of that we have a modest underweight to the credit asset class. Within credit, we think that leverage loans will underperform; however, we do continue to like shorter dated credit from high-quality issuers, which we think will outperform given the market environment.
Chart: An allocation dials shows overall currencies weighting being on par. The U.S. dollar, euro and yen are on par, emerging markets are slightly positive on the bar slide.
Erin: We don't have a strong view across currencies. Within currencies, we don't think that we're going to see the same strength within the U.S. dollar as we've seen over the last few years.
That said, we do think that within currencies is going to be more of a relative value opportunity, with fairly specific idiosyncratic opportunities emerging throughout the year within the emerging market currencies in particular.
Chart: An allocation dials shows munis weighting leaning more toward over than under. Investment grade, high yield and revenue bonds are positive; general obligation is negative on the bar slide.
Erin: For U.S. taxable clients we think that munis offer a really attractive source of income while maintaining diversification benefits in a risk-off environment.
Shot of U.S. Capitol Building and IRS building
Since the tax law changes in early 2017, there's been a dearth of issuance - but at the same time, demands remained constant, and this has created a really attractive opportunity for investing in munis right now.
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Past performance is not a guarantee or a reliable indicator of future results.
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 the current low interest rate environment increases this risk. Current 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. Sovereign securities are generally backed by the issuing government.
Obligations of U.S. government agencies and authorities are supported by varying degrees, but are generally not backed by the full faith of the U.S. government. Portfolios that invest in such securities are not guaranteed and will fluctuate in value. 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. 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. Currency rates may fluctuate significantly over short periods of time and may reduce the returns of a portfolio. Commodities contain heightened risk, including market, political, regulatory and natural conditions, and may not be suitable for all investors. Investing in MLPs involves risks that differ from equities, including limited control and limited rights to vote on matters affecting the partnership. MLPs are a partnership organised in the US and are subject to certain tax risks. Conflicts of interest may arise amongst common unit holders, subordinated unit holders and the general partner or managing member. MLPs may be affected by macro-economic and other factors affecting the stock market in general, expectations of interest rates, investor sentiment towards MLPs or the energy sector, changes in a particular issuer’s financial condition, or unfavorable or unanticipated poor performance of a particular issuer. MLP cash distributions are not guaranteed and depend on each partnership’s ability to generate adequate cash flow. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and while generally supported by a government, government-agency or private guarantor, there is no assurance that the guarantor will meet its obligations. The credit quality of a particular security or group of securities does not ensure the stability or safety of the overall portfolio. Diversification does not ensure against loss.
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