Presentation on theme: "Thank you for joining me to review Putting Markets in Perspective."— Presentation transcript:
1Thank you for joining me to review Putting Markets in Perspective. This presentation summarizes PIMCO’s expectations for the world’s economies and financial markets over the next 6 to 12 months. We refer to this as our cyclical outlook.I think you will find today’s insights and perspectives valuable in understanding how we are positioning our portfolios, but also in how you may help guide your clients through these challenging times.
2Are Not Bank Guaranteed Bank of America Corporation (“Bank of America”) is a financial holding company that, through its subsidiaries and affiliated companies, provides banking and investment products and other financial services .Merrill Lynch, Pierce, Fenner & Smith Incorporated is a wholly-owned subsidiary of Bank of America Corporation, and a registered broker-dealer and member of FINRA and SIPC.Investment products provided by Merrill Lynch, Pierce, Fenner & Smith, Incorporated:The views and opinions expressed in this presentation are not necessarily those of Bank of America Corporation; Merrill Lynch, Pierce, Fenner & Smith Incorporated; or any affiliates.Nothing discussed or suggested in these materials should be construed as permission to supersede or circumvent any Bank of America, Merrill Lynch, Pierce, Fenner & Smith Incorporated policies, procedures, rules, and guidelines.Merrill Lynch, Pierce, Fenner & Smith Incorporated is not a tax or legal advisors. Clients should consult a personal tax or legal advisor prior to making any tax or legal related investment decisions.Are Not FDIC InsuredAre Not Bank GuaranteedMay Lose ValueReview Slide with participants.
3Introduction Financial markets PIMCO’s process Cyclical insights Economy GlobalU.S.EuropeEmerging marketsFinancial marketsEmerging market debtCreditIncomeMunicipalsSpecifically, I am going to cover PIMCO’s outlook for the global economy, the U.S., Europe, and the emerging market economies. Then, I will explain where we see challenges and opportunities in a few key segments of the financial markets.But before we get into our outlook, I’d like to take just a few minutes to explain how PIMCO develops and implements these views.
4PIMCO’s Cyclical Forums: Reading the road PIMCO’s Cyclical Forums take place three times a year and distill extensive analysis into the market views highlighted in this presentation.Long-term secular inputs and analysis to set guardrails, and short-term cyclical inputs to help set near- term strategyForumsDevelop and implement portfolio strategies, combining top-down and bottom-up analysis to actively manage portfoliosPortfolio ManagersInvestment CommitteeDistills insightsfrom across PIMCO into specific investment themesBOTTOM UPTOP DOWNPortfoliosmanaged within mandated parameters and consistent with the firm’s viewsThis graphic summarizes the process PIMCO has been using to manage client portfolios through a range of market and economic environments for 40 years.We deliberately chose a circle to illustrate our process in order to stress the constant link between our top-down macroeconomic thinking and our bottom-up credit analysis and research.I am sure you hear other managers saying something similar about combining top-down and bottom-up, but what I think is unique about PIMCO is that this process is part of our DNA – it’s ingrained in all that we do and it is firm-wide. This isn’t what one PM is forecasting and positioning for. Our macro view is the combined thinking of our investment professionals through our Investment Forums – this blue section on the left.The Secular Forum is an annual event, where PIMCO’s investment professionals from around the world gather for three days of discussion and sometimes heated debate to determine our outlook for the next 3 to 5 years. That outlook is constantly being challenged and tested, including at our quarterly Cyclical Forums, where we develop our outlook for the next 6 to 12 months and refine our long-term forecast against current facts on the ground.PIMCO’s Investment Committee, as shown here in the green section, uses these outlooks to identify attractive investment themes and risk controls for portfolio managers. PMs focus on the themes best suited to their portfolios, based on the objectives and mandates, and then work with our specialty desks and extensive research teams to develop and implement specific trade strategies, which is the bottom part of the circle.
5“The global economy will likely experience steady broad-based growth in The key question now is whether this period of tranquility can last for more than just one year.”— Saumil H. ParikhManaging Director Cyclical Forum LeaderSo let’s begin with what we are thinking right now.Our outlook for global growth in 2014 remains steadily optimistic. This is due in part to rising asset prices combined with diminishing fiscal uncertainties that will likely bring stability to what has been an on-again, off-again global recovery.While our outlook for global growth is brighter, our prospects for the underlying major economies are more differentiated. We see improving conditions in the U.S. and eurozone, which prompted us to modestly increase our growth forecast. However, economic and policy uncertainty in Japan and China led us to lower our growth expectations for those countries.This shift from synchronized to fragmented growth – economies moving at different speeds and in different directions – will likely create near-term challenges.Hopefully, today’s presentation will provide information that will be helpful in understanding the risks and the opportunities that exist in this current environment.Let’s start with the big picture.
6Global economyWe expect global growth of 2.5%–3.0%, driven largely by modest increases in our expectations for the U.S. and the eurozone.We have modestly raised our expectations for global growth – due in large part to our upgraded outlook for the U.S. and Europe. We expect global growth of roughly 2.5% to 3.0%, fueled mainly by the U.S. and eurozone.ECONOMY
7PIMCO forecasts steady global growth ... This slide gives an overview of our real GDP forecasts for the world and select economies.The blue bars show the actual growth over the last 12 months. The green bars show PIMCO’s forecast for the next 12 months.As you can see, we raised our forecasts for the U.S. and Europe. In contrast, we’ve lowered our expectations for growth in Japan and China, given both economic and policy uncertainty that could hinder progress this year.Our outlook for emerging markets remains relatively steady in the near term.Source: Bloomberg, PIMCO. Current data for real GDP represents four quarters ending Q World is a weighted average sum of countries listed in the chart.ECONOMY
8… although monetary policy expectations are diverging While we see increased stability in the global recovery, we are watching closely for ripples from diverging monetary policies, as highlighted in this table.This table shows changes in policy rates in developed and emerging markets from , when major central banks moved in unison to support the recovery following the financial crisis.But as we move into more of a multi-speed environment monetary policy is becoming more specific to the unique needs of each country. On the right, for example, the U.S. is moving toward normalization while Europe is contemplating additional easing. And while Brazil hikes rates, China is maintaining lower rates to support its slowing economy.Multi-speed growth and divergent policy reactions could create opportunities for investors who are able to take advantage of this differentiation by managing their exposures across a variety of global yield curves, and able to closely monitor changing conditions at a country, sector and security level.Source: BloombergECONOMY
9U.S. economyOur expectation of 2.5%–3.0% real growth in the U.S. recognizes the continuing transition from policy-assisted to demand-driven growth.Now let’s look at our expectations for the U.S. economy.Over the next 12 to 18 months, we’ll look for the drag from fiscal policy to abate and for corporations and consumers to gain enough confidence to increase spending. These expectations have supported our upgraded growth outlook for 2014.ECONOMY
10The Fed has backed away from its unemployment threshold … The outlook for monetary policy is less certain. The Federal Reserve (Fed) said last year that it would consider rate hikes when unemployment reached 6.5% and inflation 2%.However, with unemployment in the first quarter very close to the 6.5% target, as seen by the blue line in the chart here, Fed Chair Janet Yellen dropped references to the unemployment target from the Fed’s March statement and placed greater emphasis on inflation and other, in her words, “measures of labor market conditions.”Source: Bureau of Economic Analysis, Haver. Data through 31 January *Year-over-year percentage change in the core personal consumption expenditure deflator.ECONOMY
11… although trends in short-term unemployment suggest wage pressures may be rising That does not mean, however, that the Fed and investors won’t be watching employment data.This chart shows long-term (the blue line) and short-term (green line) numbers for the official unemployment rate – the U3 – which tracks individuals who are unemployed but actively seeking jobs.While long-term unemployment remains high, short-term unemployment is already back to pre-crisis levels. This is important because short-term unemployment may be a key driver of wage inflation, which in turn could push overall inflation towards the 2% threshold.Improving growth prospects suggest fixed income investors may want to reduce duration – that is, interest rate sensitivity -- in favor of selective credit risk and flexible bond strategies. Equity investors should consider holding cyclical stocks with strong fundamentals.With gradually rising inflation on the horizon, investors may also want to hold or opportunistically add TIPS.Source: Bureau of Labor Statistics. Data through 31 January Long-term unemployment refers to a subset of the U.S. Bureau of Labor Statistics U3, defined as people who have been unemployed for more than 26 weeks but who actively looked for work within the past four weeks. Short-term unemployment is also a subset of U3 for people who have only been unemployed for less than 26 weeks.ECONOMY
12European economyWe are forecasting real growth of 1.0%–1.5% for the eurozone, reflecting improved conditions in peripherals and greater access to capital markets.In the eurozone, our baseline expectation calls for a broad-based cyclical improvement in consumer and business confidence, reduced fiscal drag and gradually improving credit conditions.ECONOMY
13The eurozone has recovered from its double-dip recession … This improved confidence is evident in the chart here, which shows an improving Purchasing Managers’ Index (PMI). PMI is a widely recognized measure of business sentiment, with a PMI of 50 or higher suggesting the economy is expanding. The Eurozone PMI (shown as the blue line) has been steadily rising and is now moving back in line with the U.S. (where the green line represents supply management data).Source: Markit, ISM, PIMCO. PMI is Purchasing Managers’ Index, data through February ISM is the Institute of Supply Management Index, data through January 2014.ECONOMY
14… and improving growth extends beyond Germany Importantly, Europe’s recovery is now being fueled by more than just Germany. As this GDP growth chart shows, Germany (the brown line) carried the Eurozone’s economy after the crisis, while Italy and Spain contracted. But now, all of the “big 4” (meaning Germany, France, Spain and Italy) are contributing to GDP growth.Despite these positives, Europe continues to face significant structural headwinds that could challenge the recovery, including high unemployment and a lack of credit growth.Investors who have shied away from Europe in recent years will want to consider opportunities across the region, including overweighting select periphery sovereign debt and underweighting the U.K. In equities, we are focusing on select multinationals with exposure to growth markets.Source: Eurostat. Data through December 2013.ECONOMY
15Emerging marketsEmerging markets’ growth advantage will continue, with GDP (ex. China) increasing about 3% in But, a slowing China poses risks to the EM outlook.Now let’s turn to emerging markets.While EM growth continues to outpace growth in developed markets, the gap is smaller than in recent years. In addition, we see greater variations among various EM countries.ECONOMY
16EM depends on China as a buyer … As the chart here suggests, this relates in part to China, which plays an outsized role in determining the outlook for export-driven EM economies given its sheer size.This chart shows major EM economies and the percentage of their exports that went to China in ranging from Korea at 25% to Russia at 7%.So what happens if China heads into a growth slowdown?Source: International Monetary Fund (IMF), 2012 data as reported during 2013.ECONOMY
17… and is vulnerable to a potential China slowdown This chart suggests that China is decelerating, with industrial production (the green line) slowing and PMI (shown as the blue line) suggesting economic contraction.To some extent, the slowdown reflects the transition from export and investment-led growth to consumption among a growing middle class in China. But the government also retains tremendous policy flexibility to ensure a relatively smooth adjustment, leaving PIMCO fairly optimistic about China’s prospects. In addition, valuations have cheapened significantly over the past few quarters.While investors need to recognize the uncertainties, there are still attractive opportunities in the region for long-term investors.Source: China National Bureau of Statistics, HSBC/Markit. IP data through December 2013, HSBC PMI data through February 2014.ECONOMY
18Economy Key topics Implications PIMCO’s outlook Global U.S. European Steady, though multi-speed, growth of 2.5%–3.0%Invest globally to take advantage of opportunities presented by differentiation in growth rates and policy responsesU.S.Real growth of 2.5%–3.0% as economy transitions to demand-driven growthFixed income investors may want to reduce duration in favor of credit risk. Equity investors may want to favor cyclicals with strong fundamentals.European1.0%–1.5% real growth reflecting improved conditions in peripheralsOverweight select periphery sovereign debt and underweight U.K., focus on select multinational stocks with exposure to growth markets.Emerging marketsGrowth advantage will continue but slowing China poses risksRecognize the uncertainties but know that the fundamental case for emerging market investing remains intactEconomyLet’s take a minute here to recap what we’ve talked about so far.This is a summary of PIMCO’s economic forecasts and the implications for each region we’ve discussed.On the global front, steady but fragmented growth of 2.5% to 3.0%.In the U.S., real growth of 2.5% to 3.0% as the economy transitions to demand-driven growth.In the Eurozone, we expect 1.0% to 1.5% real growth, reflecting improved conditions in peripherals.And finally, in the emerging markets, the growth advantage will continue but slowing China poses risks.Now let’s move on to what PIMCO expects in a key sectors of the financial markets.ECONOMY
19Emerging market debtWe continue to find selective opportunities in emerging market countries with sound fundamentals.Now, let’s take a look specifically at our outlook for EM debt, where we continue to see select opportunities among countries with solid fundamentals.FINANCIAL MARKETS
20Flows into EM have sharply reversed … Emerging market (EM) fixed income markets have seen a sharp sell-off since the highs of as the blue line in this chart shows.While flows do not predict performance, you can see a clear correlation between assets flowing into this category and returns for EM local and external debt (the brown and green lines respectively). So, investor appetite for EM will remain an important variable to monitor.Source: J.P. Morgan. Data through February J.P. Morgan Emerging Markets Bond Index Global. J.P. Morgan Government Bond Index-Emerging MarketsFINANCIAL MARKETS
21… but country analysis shows select opportunities remain Equally as important, however, are the increasingly differentiated fundamentals across EM. The blue dots depict the current account deficits for several countries – amounts which are generally financed by foreign investors.While the size of deficit itself may be a source of concern, the true susceptibility lies in how it is being financed. Foreign direct investment (FDI) – a foreign company building a factory, for example – is generally considered a higher quality source of funding, particularly compared to more fickle flows into a country’s debt or equity market.So, as you can see, while Mexico and Brazil are running deficits (the blue dots), they receive large amounts of FDI (the green bars), suggesting they are less susceptible to a souring of investor appetite than Turkey or South Africa, both of which have larger deficits and less FDI.Investors will want to be selective regarding EM debt, potentially favoring countries with stronger fundamentals and limited susceptibilities.Source: J.P. Morgan. Data through 10 February 2014.FINANCIAL MARKETS
22CreditImproving fundamentals have led to tighter credit spreads but we continue to see opportunities for return.Now let’s discuss PIMCO’s outlook on select credit sectors.The broad U.S. bond market fell 2% in 2013, but the high yield market, as measured by the Merrill Lynch High Yield Index, returned more than 7%. The equity market played an important role in supporting high yield and other credit markets.FINANCIAL MARKETS
23The stock market has delivered strong returns ... Here is the S&P 500 Index from 2000 to early 2014, including the run-up in the equities market beginning in So, the question is: Why would an equity market rally impact the credit market?Source: Bloomberg. Data through 31 March 2014.FINANCIAL MARKETS
24... influencing enterprise value and credit spreads It’s because higher equity valuations can increase a company’s enterprise value (a measure of total worth). Assuming debt does not increase much, the company’s leverage or debt-to-enterprise value falls.Debt-to-enterprise value is a measure of a company’s creditworthiness. As this chart shows, there is a strong correlation between that ratio (blue line) and the yield on high yield bonds (the green line). So, as a company’s fundamentals improve, the yield on the bond can fall, resulting in price increases.The lesson here is that investors may benefit from an equity rally by holding credit. And credit can continue to provide positive return potential even when other fixed income markets are not.But remember that identifying credits with improving fundamentals requires in-depth credit research and independent research capabilities.Source: Capital IQ, Markit. Data through 12 December 2013.FINANCIAL MARKETS
25IncomeWe continue to find attractive risk-adjusted opportunities for income in non-agency MBS and discounted assets sold by deleveraging European banks.Now let’s look at where PIMCO is finding opportunities in the income sector.FINANCIAL MARKETS
26U.S. non-agency MBS market continues to provide an attractive source of income Given our expectation of a modest U.S. housing recovery, we remain favorable on income-generating opportunities in the non-agency mortgage-backed securities (MBS) space.This chart shows how non-agency MBS may continue to offer attractive loss-adjusted yields under varying scenarios for housing prices.Source: PIMCO. Data through 31 December Hypothetical example for illustrative purposes only. Non-agency MBS loss-adjusted yields are based on pricing from PIMCO’s survey on the market. Loss-adjusted yields represent the yield earned after expected losses on a specific mortgage bond, across a variety of scenarios. PIMCO’s loss-adjusted yield calculation currently factors in the default risk level. The two-year home price appreciation axis illustrates the different home price depreciation and appreciation levels (e.g., -10% represents 10 percent depreciation).FINANCIAL MARKETS
27New opportunities may come from European bank deleveraging PIMCO is also finding income opportunities in assets being sold by European banks. This chart shows how European banks have likely just begun a cycle of deleveraging – as reflected by the blue and green lines for the Euro area and Spanish banks at the top of the chart.A bank’s leverage is the amount of loans outstanding relative to deposits. After previous crises, significant re-regulation and political scrutiny prompted banks to de-risk by selling loans, eventually stabilizing their loan-to-deposit ratios at around 70%.In contrast, ratios for Spanish and Euro area banks are still well over 100%. To improve this ratio, these banks are selling loans on their balance sheets, providing opportunities for PIMCO to potentially purchase high quality assets at attractive prices.Individual investors may not be able to easily access the type of distressed asset sales described here. Banks that are deleveraging tend to sell large, complex portfolios, and PIMCO is in a position to evaluate and purchase these assets.Source: PIMCO, BIS, Morgan Stanley, CEIC, SNL Financial, FDIC. Data through 30 September 2013.FINANCIAL MARKETS
28MunicipalsSupply pressures and headline risk will feed market volatility, creating buying opportunities for research-based managers.I’ll conclude our discussion with a look at the municipal bond market.Supply/demand imbalances are increasingly important in today’s municipal market. As you know, the law of supply and demand dictates that high demand and low supply levels should support more attractive returns.FINANCIAL MARKETS
29Primary market supply is low … And this chart shows that new issuance supply is low in 2014.Source: Bond Buyer, data through 19 March 2014.FINANCIAL MARKETS
30… and changes in secondary supply conditions are increasing market volatility At the same time, we have seen an increased demand in the form of modestly positive mutual fund flows in 2014 – the green spikes at the right.When considering supply/demand imbalances, investors should also consider changes that are happening in secondary market. Before the credit crisis, the market could expect institutional buyers (i.e., leveraged municipal hedge funds) to provide secondary demand when individual investors were selling. This institutional demand helped to dampen volatility. Since 2008, however, secondary demand has fallen off and the municipal market has seen greater price volatility in times of broad-based retail selling.In 2013, the result was meaningfully higher yields and a dearth of liquidity.The municipal market continues to evolve, presenting investors with new opportunities but also new risks. In this environment of greater volatility and headline risk, independent credit research capabilities are more important than ever.Source: Lipper for flows, Thomson Reuters Municipal Market Data for yields. Data through 19 March 2014.FINANCIAL MARKETS
31Financial markets Key topics Implications PIMCO’s outlook Emerging market debtContinue to find selective opportunities in emerging market countriesFavor countries with strong fundamentals and limited susceptibilities to investment flowsCreditImproving fundamentals have led to tighter credit spreads but we continue to find opportunitiesFocus on credits with improving fundamentalsIncomeContinue to find opportunities in non-agency MBS and high quality, discounted assets from European bank deleveragingFavor active managers with the size and expertise to access opportunitiesMunicipalsSupply pressures and headline risk will feed volatility, creating buying opportunitiesTake a long-term perspective and focus on independent credit researchHere is a summary of what we just covered for the financial markets:We continue to find selective opportunities in emerging market debt.In the credit market, improving fundamentals have led to tighter credit spreads. But we continue to find opportunities.For income-producing bonds, we favor non-agency MBS and high quality, discounted assets from European bank deleveraging.And in the muni market, we expect supply pressures and headline risk to feed volatility, potentially creating buying opportunities.I realize that we have covered a lot of ground here today, and yet this presentation only touches on a portion of the topics PIMCO discusses at our Cyclical Forums. For a more comprehensive look into our cyclical forecasts, I strongly encourage you to visit our website global.pimco.com/puttingmarketsinperspective and access our extensive library of thought leadership materials.FINANCIAL MARKETS
32Any questions?In the meantime, I am happy to take any questions that you may have.
33AppendixPast performance is not a guarantee or a reliable indicator of future results.FORECASTForecasts, estimates and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve.HYPOTHETICAL EXAMPLEHypothetical and simulated examples have many inherent limitations and are generally prepared with the benefit of hindsight. There are frequently sharp differences between simulated results and the actual results. There are numerous factors related to the markets in general or the implementation of any specific investment strategy, which cannot be fully accounted for in the preparation of simulated results and all of which can adversely affect actual results. No guarantee is being made that the stated results will be achieved.INVESTMENT STRATEGYThere is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market.OUTLOOKStatements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.RISKInvesting in the bond market is subject to certain risks, including market, interest rate, issuer, credit and inflation risk; investments may be worth more or less than the original cost when redeemed. Bank loans are often less liquid than other types of debt instruments. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. 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. Mortgage- and asset-backed securities may be sensitive to changes in interest rates, subject to early repayment risk, and their value may fluctuate in response to the market’s perception of issuer creditworthiness; while generally supported by some form of government or private guarantee, there is no assurance that private guarantors will meet their obligations. Investing in securities of smaller companies tends to be more volatile and less liquid than securities of larger companies. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Certain U.S. government securities are backed by the full faith of the 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. Investing in distressed companies (both debt and equity) is speculative and may be subject to greater levels of credit, issuer and liquidity risks, and the repayment of default obligations contains significant uncertainties; such companies may be engaged in restructurings or bankruptcy proceedings. Entering into short sales includes the potential for loss of more money than the actual cost of the investment, and the risk that the third party to the short sale may fail to honor its contract terms, causing a loss to the portfolio. Derivatives may involve certain costs and risks, such as liquidity, interest rate, market, credit, management and the risk that a position could not be closed when most advantageous. Investing in derivatives could lose more than the amount invested. Diversification does not ensure against loss.