Daniel Ivascyn
After its annual ‘Secular Forum’, which this year boasted speakers such as Ben Bernanke, Rob Arnott, Dr Anat Admati and Jean-Claude Trichet, as well as the PIMCO investment team leaders, the manager produced a cautiously optimistic report and a set of guidelines for global investors to follow.
The report sets out six trends in which it will be necessary to invest in order to succeed, PIMCO believes. However, taking advantage of these trends will be insufficient for success unless six concurrent tail risks are hedged against over the next three-five years.
The six secular trends driving global markets are:
> converging to ‘new normal’ potential growth rates in developed and emerging economies
> evolving to a re-regulated, better capitalised global banking system
> moving from energy scarcity to energy abundance unlocked by the shale revolution
> accelerating from deflation and towards a target 2 per cent inflation in major economies
> shifting (a nascent trend) from a global savings glut supported by lower commodity prices and towards narrowing global imbalances amid stronger global demand, which will depend to some extent on whether China can succeed in making the middle-income transition, and
> implementing (another nascent trend) better economic policy in key emerging economies, such as China and India, as well as key developed economies, such as eurozone and Japan, with at least the possibility of future breakthrough in US economic policy, in areas such as immigration, oil exports and trade promotion authority.
The six key tail risks to the secular trends are:
> with trend growth rates and inflation modest, policy rates low, public balance sheets bloated and public debt high, few countries would have room to manoeuvre to deploy counter-cyclical policy were the global economy to go into recession within the next five years
> the re-regulated, better capitalized global banking system allocates little of its balance sheet to making markets, resulting in greater likelihood of flash crashes, air pockets and trading volatility
> the trend away from energy scarcity and toward energy abundance creates big losers as well as winners and is only positive for global demand if the winners’ boost in consumption offsets the losers’ cut in consumption and capital spending.
> geopolitical conflicts have thus far been taken in stride by markets but ‘disaster risk’ is to some extent priced into financial assets today and is a source of volatility and downside risk to equity prices and credit spreads and upside potential to treasury and bund prices
> the distribution of global inflation outcomes has a right tails as well as a left tail; over a five-year horizon, a breakout of inflation to the upside of central bank inflation targets is not as unlikely as many seem to assume
> a trend is called ‘nascent’ for a reason – there is a risk it does not develop and there is a risk to the optimistic baseline that foresees better economic policy in key emerging and developed economies and the possibility of future breakthroughs in US economic policy over the secular horizon; there remains a tail risk of political polarisation in the Eurozone and/or a British exit fro, the EU; in China, the planned reforms are ambitious and success is not assured and capital account liberalization, in particular, will be challenging to accomplish in the time frame announced.
The big changes since PIMCO’s last ‘Secular Forum’ in May last year has been valuations, especially of US bonds close to the ‘new neutral’, and continued dedication to reflation by the Eurozone and Japan and to structural reforms by China and India.
The PIMCO report was written by Daniel Ivascyn, global CIO, Andrew Balls, CIO of global fixed income, and Richard Clarida, global strategic advisor. The guest speakers at the forum were: Dr Anata Admati, professor of finance and economics at Stanford; Rob Arnott, founder of Research Affiliates; Ben Bernanke, former chair of the US Federal reserve and a PIMCO advisor; Dr Gary Gorton, professor of management and finance at Yale; Leon Panetta, former US Secretary of Defense and a director of the Central Intelligence Agency; Jean-Claude Trichet, former president of the European Central bank; and, Dr Daniel Yergin, Pulitzer Prize-winning author and expert of energy and geopolitics.
