The global macro environment will continue to be anything but normal over the next five years. Investors will have to tread a volatile and challenging path. “Our expectations for a more volatile macroeconomic and market environment call for low and realistic expectations for asset market returns over the secular horizon.”
That is what Andrew Balls (photo) and Dan Ivascyn, the co-heads of investment strategy at Pimco, wrote in their outlook for the next five years. According to the US specialists in fixed-income securities, disruption and uncertainty are likely to continue.
“Deglobalisation will widen rifts in the global economy,” said the strategists in their outlook for the second half of 2022. “A thoughtful, long-term focus should help investors along that challenging path.”
Potential for surprise outcomes
Policymakers will increasingly focus on security. This will result in increased defence spending and greater diversification in supply chains. These trends could adversely affect economic efficiency and increase inflationary pressures.
Investors should diversify their portfolios on the basis of geopolitical risks, Pimco said. “There is the potential for surprise outcomes,” the CIOs wrote. As an example, they cite Russia’s isolation from the global financial system in response to the invasion of Ukraine.
“Governments and companies will be under pressure to clarify whose side they are on along geopolitical divides, risking sanctions, capital controls, and ultimately confiscation. As well as diversification across asset classes, these geopolitical considerations may have implications for investment decisions and required risk premia.”
Next recession unlikely to be deep
Stubbornly high inflation, central banks’ focus on fighting it, and geopolitical tensions significantly increase the likelihood of a recession in the next two years, the bond house strategists said.
“The next recession is unlikely to be as deep as the Great Recession of 2008 or the COVID sudden stop of 2020, it may well be more prolonged and/or the following recovery may well be more sluggish due to a less vigorous response by central banks and governments.”
Pimco reckons that the search for resilience in portfolios will become more important than the search for yield. Fixed income will play an important role in building resilience in diversified portfolios.
Higher equity risk premia expected
Returns in the major bond markets have recovered, and the various policy rates are unlikely to rise further than the market has priced in at the moment, according to Pimco. Factors that have pushed neutral rates down in recent decades, such as demographics, global savings and high debt, will remain intact in the period ahead.
Only an unexpected increase in inflationary pressures could push yields past market expectations, Pimco said. US 10-year bond yields are expected to be similar to, or slightly higher than, the past decade with a range of 1.5 to 4 percent.
Equity markets will offer lower return prospects than investors have experienced since the global financial crisis, it said. “Given diminished visibility on growth and profitability, investors are likely to require higher equity risk premia and prioritise reliable earnings.”
Positioned to provide liquidity
The investment strategists write in their outlook that US Treasury Inflation-Protected Securities, or Tips, offer reasonably priced coverage in times of higher inflationary pressures. The same applies to real estate and commodities, especially in the energy sector, the strategists said.
In the corporate bond market, where excesses are increasingly occurring according to the fund house, high-quality corporate bonds are preferred. “We will look to avoid positions that would expose us to any significant default risk in a sustained credit default cycle and to position ourselves to provide liquidity, not to demand liquidity, during periods of credit market stress.”
Emerging markets can also offer good returns over the next five years, according to Pimco, provided an active strategy is adopted. Investors there operate amid sanctions, confiscation risks and the possibility of surprises determined not only by domestic political volatility, but also by regional and global political factors.
“A world of greater home bias of market participants, greater deglobalization, and more fragmentation of capital markets may lead to opportunities for investors with a global mindset and the investment teams to seek out and take advantage of the opportunities,” the Pimco strategists said.
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