PIMCO’s Cyclical 2010 Outlook

Here is asset allocation in action. PIMCO has cut risk exposure because it fails to see a clear path to the economy in 2010.

  • The global economic recovery underway will likely be very much de-synchronized, borne of heterogeneous initial conditions on display prior to the recession, with a full range of possible outcomes.
  • (…) there is still uncertainty over three major issues, which in turn creates a range of possible outcomes in our forecast. (…)


    • The first issue is the peg between the Chinese yuan and the U.S. dollar, which essentially gives us a one-size-fits-all monetary policy in a very differentiated world. (…) If China were to let its currency appreciate, it could regain a degree of monetary policy autonomy and a better ability to manage the risk of overheating and asset price inflation. Another outcome, however, is that China refuses to let the yuan appreciate, essentially maintaining too easy of a monetary policy for itself and the developing countries that shadow Chinese policies. This would create bubble risk, particularly for assets such as emerging market (EM) equities and commodities.
    • The second major uncertainty is what will happen when the Fed completes its mortgage-backed securities (MBS) buying programs. We know that it will have an unfriendly effect on the interest rate markets, but we don’t know the magnitude, because it’s too hard to isolate the supply and demand dynamics between fundamentals and the stimulus programs.(…)
    • The third uncertainty is any change in the Fed’s pre-commitment language, which is currently committed to keeping the fed funds rate exceptionally low for an “extended period.” We don’t think the Fed is going to tighten any time in 2010, but long before the FOMC (Federal Open Market Committee) actually does the deed, it will have to change its language. That could very well happen in 2010, and there is genuine uncertainty over how quickly and strongly the market will anticipate a tightening process. Our gut feeling is that the moment the Fed changes any one of its words, it’s going to be a very unpleasant experience, because the marketplace has very little patience and a very big imagination.(…)
  • We don’t think the U.S. is going to get a new stimulus package, but there will be a hodgepodge of things that fit the description. In fact, that’s one of the reasons that the Treasury has been pushing so hard for the banks to pay back Troubled Asset Relief Program (TARP) money, because the president plans to ask to Congress to move TARP money into Cash for Caulkers and other job stimulus measures. So we will get fiscal stimulus, but it will not be as big or explicit as what we’ve had so far.
  • The big unknown gets back to what we’ve already discussed: We’re probably going to have a $1.4 trillion deficit this year without the Fed on the buy side of the market for duration. There is major uncertainty about how the supply/demand equation for duration will resolve itself when the Fed is out of the picture.(…)
  • That said, we do have forecast numbers that generally capture the spirit of our discussions: sturdy growth in the emerging markets space, even if less than the Old Normal, and slower growth in the developed countries. Inflation, meanwhile, will probably be too low in the developed world because of still-huge output gaps. What the forecasts can’t tell, however, is that asset price inflation – including commodities – is becoming a more important dimension in our forecast because it’s becoming a more influential component of central banks’ reactions around the world.
  • The real story here will be told not in the GDP numbers, which are being driven by the inventory cycle, but by real final sales, which will continue to face the headwind of balance sheet deleveraging in the household sector. This is a critical tenet of the New Normal. Consumers can’t and/or won’t augment personal income by borrowing, so consumption must grow in line with personal income. Consumption isn’t likely to get a boost from the increase in stock market wealth because home values – a larger part of individual wealth – are still depressed. Thus, savings rates may stabilize at 4% or 5%, but may go as high as 8%.
  • As we translate all of this into investment strategy, we have to be incredibly cognizant of lingering uncertainties and the full range of potential outcomes. Because that range is so wide right now, our risk-taking is more tame than it would be if we had a normal distribution of expected outcomes. (…)
  • This all leaves us with portfolios that appear, more than at other times, to be hugging the benchmarks with no bold positioning.(…) we’re making a very active decision to run light on risk.
  • For interest rate exposure, or duration, we are currently cutting back in the U.S. and U.K. because, as mentioned before, supply and demand dynamics are likely to be negatively affected as borrowing rises and central bank buying declines. On the other hand, we remain modestly bullish on duration in the Eurozone, which has been congenitally disinclined to be aggressively Keynesian and won’t face the same degree of reduction in central bank duration buying in 2010. Regarding curve duration, we continue to remain modestly overweight.
  • With corporate bonds, we are becoming a bit more cautious than we have been. (…) Now, we’re generally neutral versus the benchmark, but we believe that corporate spreads are still at levels where we see value in carefully selected high-quality credits, particularly in bank and non-bank financials and non-cyclical sectors, such as utilities and healthcare.
  • In high yield corporate, we are adding very select names in telecoms and energy pipelines that we view as “money good.” In agency MBS, we are underweight, having reduced our exposure as the Fed’s buying programs have dramatically tightened spreads.
  • Our overall currency target is to be about 3% long a basket of emerging market currencies, generally against the benchmark portfolio currency. Similarly, we’re favoring emerging market sovereign credits, and the Dubai panic gave us additional legroom to enter into these trades. We are also adding to positions in EM corporate bonds.
  • Though we view Treasury Inflation-Protected Securities (TIPS) as a strategic long-term allocation, on a tactical basis we are underweight TIPS versus the benchmark, reflecting our view that risks are currently weighted toward a disinflationary environment. (…)


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