Tina Adatia, Fixed Income Strategist:Hi my name is Tina Adatia, and I’m a product strategist here at PIMCO. And I’m joined by colleagues Joachim Fels, our global economic advisor, and Dan Ivascyn, our group CIO to discuss portfolio implications based on our secular outlook. Given this backdrop of lower growth, lower rates, what can investors expect in terms of returns and risk?
Dan Ivascyn, Group Chief Investment Officer:Sure. So we'll start with some, you know, some news that's not so good. The last decade, returns have been pretty strong and volatility has been relatively low.
On a go-forward basis, when we look at financial markets, whether it's equities or fixed income, commodities,
Chart: A chart lists the secular market trends that can increase volatility while decreasing returns. The trends include elevated valuations, lower yields for longer, higher volatility and challenging liquidity conditions.
we expect returns to be a lot lower and volatility to be higher. And that's a very challenging environment for all of us as investors.
So this is an environment where investors have to have a different mindset in terms of the ability to achieve their investment outcomes through riding the betas or beta returns alone, and will require a more creative approach to investing and, in that process, targeting a much wider opportunity set.
Tina Adatia:I want to talk a little bit about volatility. So Joachim, what do we expect from volatility going forward?
Chart: A bar chart compares realized volatility levels (by year, starting in 1929) moving from lowest volatility to highest. The chart calls out lower-than-average years including 2017 and 2019 (less than 10%), average years like 2018 (about 15%) and high years like 2008 (above 40%). Since 2008, more years have had lower-than-average volatility, not higher.
Joachim Fels, Global Economic Advisor:I think people felt like last year was a very volatile year with all that happened in financial markets. And as the chart shows, you know, this was just a return to normal historical averages. And the real aberration was really what we saw in 2017 and some of the years before.
And our view is, going forward next several years, we will see volatility rising further. And you know, we think on average it will probably be above that long-term average that we have seen in the past.
Tina Adatia:Okay. So lower returns, higher volatility going forward. So what is our view generally on interest rates, Joachim, and how do we position from an interest rate perspective?
Chart: A double line graph represents a descending federal funds rate relative to the descending yield of U.S. 10-year Treasuries from 1983 to 2018.
Joachim Fels:We think rates are still pretty much anchored by the new neutral. Now, in the next recession, which we think is quite likely at some stage over the next three to five years, while it's quite likely that rates go back down to zero, we think the Fed is still unwilling to go negative. The experiment in other countries has not been that great, that successful.
And so, this is why when we move to bond yields, to the outlook for longer-term yields, we think the range, the new neutral range for ten-year yields outside of recession is probably 2% to 3%. We're now getting closer to that lower end of that range, but we're not there yet.
Tina Adatia:Now shifting to corporate credit and credit in general, Dan, what are PIMCO's views on corporate credit today?
Chart: A chart compares corporate credit levels (2008 versus 2019): growing market (increase), increased credit risk (increase), higher leverage (increase) and reduced compensation for risk (decrease).
Dan Ivascyn:This is a challenging environment. You've had issuance that's elevated from a historical perspective. You've seen a strong demand for yield, which has led to a deterioration in credit metrics, less investor protections, and spread levels from historical perspective look average at best.
So we think that this is the one sector in the market over the next five years that's prone to more material overshooting of fundamentals. So in constructing a portfolio, this is an area where we're the most cautious, where we as a firm are trying to find additional sources of yield, carry, return while sheltering our client portfolios from what we'd categorize as a lazy credit overweight or excessive exposure to that corporate data.
Tina Adatia:Shifting to another sector and another source of spread, securitized assets and mortgages. So house prices have risen, here and globally, but we've also seen that actually housing metrics have actually improved in terms of the underlying fundamentals.
Chart: A line graph shows U.S. investment grade corporate net leverage from 2007 to 2018 rising, falling slightly and then rising again. A second line graph shows legacy non-agency combined loan to value ration from 2007 to 2018 rising and then falling.
We've seen delevering of homeowners, which you see in this chart here, compared to actually, corporate credit has actually relevered.
So, tell us your view on housing and securitized assets.
Dan Ivascyn:Yeah. So looking at, you know, relative opportunities, we look at the US housing market, even other global housing markets, that have faced significant regulation since the global financial crisis. And we see quite stable fundamentals. In addition to looking at bonds that explicitly have loans to homeowners backing them, but even in corporate credit sectors that are tied to the housing market, we believe are areas that should be represented in terms of overweights across portfolios.
We've seen significant deleveraging across that space. And today when you look at the type of lending that's going on in that marketplace, it's much, much more conservative today than it was pre-financial crisis. The housing market is the one area where you still see excessive conservatism, and therefore value for those lending into that sector.
Tina Adatia:Thank you Joachim and Dan, and thank you everyone for listening today. If you've got any other questions, please contact your PIMCO representative. Thank you and have a good day.
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