By: Joachim Fels, Andrew Balls & Dan Ivascyn
Investors and policymakers will likely face a radically different macro environment over the next five years as the New Normal decade of subpar-but-stable growth, below-target inflation, subdued volatility, and juicy asset returns fades into the rearview mirror. What lies ahead is a more uncertain and uneven growth and inflation environment in which overall capital market returns are likely to be lower and more volatile.
In our latest Secular Outlook, “Age of Transformation,” we discuss ongoing disruptors as well as three trends that we believe will drive a major transformation of the global economy and markets. This transformation should yield good alpha opportunities for active investors capable of navigating the difficult terrain. As always, our outlook derives from our annual Secular Forum, which included PIMCO’s global investment professionals and Global Advisory Board as well as distinguished guest speakers. (This behind-the-scenes video offers a look at our forum process.) This blog post is a distillation of our outlook and investment views.
Drivers of transformation
In our 2020 Secular Outlook, “Escalating Disruption,” we argued that the COVID-19 pandemic would serve as a catalyst for accelerating and amplifying four important secular disruptors: the China–U.S. rivalry, populism, technology, and climate change. Developments over the past year have reinforced those expectations.
These four disruptors, along with the three secular trends below (which we discussed in depth at the 2021 Secular Forum), will have important implications for economic and investment outcomes in the Age of Transformation.
The transition from brown to green. Efforts to achieve net zero carbon emissions by 2050 mean that both private and public investment in renewable energy will be boosted for years to come. Of course, higher spending on clean energy is likely to be partly, but not fully, offset by lower investment and capital destruction in brown energy sectors such as coal and oil. During the transition there is a potential for supply disruptions and sharp rises in energy prices that sap growth and boost inflation. Moreover, as the process creates winners and losers, there is a potential for political backlash in response to job losses in brown industries, higher carbon taxes and prices, or carbon border adjustment mechanisms that make imports more expensive.
Faster adoption of new technologies. Data so far show a significant rise in corporate spending on technology. Similar increases in investment in the past, e.g., during the 1990s in the U.S., have been accompanied by an acceleration in productivity growth. Yet it remains to be seen whether the recent surge in tech investment and productivity growth is a one-off or the beginning of a stronger trend. Digitalization and automation will create new jobs and make existing jobs more productive. But it will also be disruptive for those whose jobs will disappear and who may lack the right skills to find employment elsewhere. As with globalization, the dark side of digitalization and automation will likely be rising inequality and more support for populist policies.
Sharing the gains from growth more widely. The third potentially transformative trend underway is the heightened focus by policymakers and society at large on addressing widening income and wealth inequality and making growth more inclusive. For example, anecdotal evidence suggests that in many companies, the balance of power in the employer-employee relationship has started to shift from the former to the latter, thus improving workers’ bargaining power. It remains to be seen whether this trend continues or whether work from home with the help of technology eventually allows companies to outsource more jobs to cheaper domestic and global locations, thus preserving or even increasing employers’ bargaining power.
Investment conclusions
We believe that the Age of Transformation will present more difficult terrain for investors than the experience of the New Normal over the past decade. But we also believe it will provide good alpha opportunities for active investors who are equipped to take advantage of what we expect to be a period of higher volatility and “fatter tails” than the common bell curve distribution.
Higher macroeconomic and market volatility is very likely to mean lower returns across fixed income and equity markets. Starting valuations – low real and nominal yields in fixed income markets and historically high equity multiples – reinforce the expectation.
In our baseline we expect low central bank rates to prevail and anchor global fixed income markets. Although we see upside risks to interest rates over the short term as economies continue to recover, over the secular horizon we expect rates to remain relatively range-bound. We expect lower but positive returns for core bond allocations.
While a sustained period of high inflation is not our baseline outlook, we continue to think that U.S. Treasury Inflation-Protected Securities (TIPS), as well as commodities and other real assets, make sense as hedges against inflation risks.
Meanwhile, macro trends, disruptors, and drivers, along with elevated debt levels, will likely lead to substantial differentiation in outcomes across regions, countries, and sectors. In Asia, the prospect of stronger growth and developing capital markets will likely provide good investment opportunities, despite the risks associated with slower growth in China and ongoing geopolitical tensions. While a number of emerging market (EM) countries face difficult secular circumstances, as always it is important to approach emerging markets as a broad opportunity set, not as a passive beta investment, and we expect to find very good opportunities across EM.
The transition from brown to green, the faster adoption of new technologies, and post-pandemic changes in supply chains and preferences will create a range of winners and losers and reinforce the importance of active management in corporate debt markets. Shifts in environmental regulation will mean uncertainty and complexity as well as opportunity. High debt levels are a particular concern in the case of countries or companies that stand to lose out in the brown-to-green transition.
Finally, we expect to remain constructive on equities in our asset allocation portfolios. We believe the post-COVID-19 recovery has underscored the need for physical infrastructure investment – after years of under-investment – owing to the trends of digitalization and automation and the push toward green adoption. Where the past decade was software-led, the coming one will be defined more by hardware investments related to these trends. The theme of differentiation and winners and losers in the recovery will be crucial across countries and sectors and at the stock selection level. In particular, we believe that semiconductor manufacturers, factory automation equipment providers, and green energy and mobility suppliers all stand to benefit, and we expect these sectors to be an important part of our portfolio construction.
In an Age of Transformation where real and nominal interest rates are likely to remain anchored at low levels, we think it makes sense to seek to maximize the opportunity in traditional fixed income strategies with flexible mandates aimed at taking advantage of the full global opportunity set. It also makes sense, in our view, to look for alternatives beyond traditional fixed income, including making use of real estate, private credit, and developing global capital markets where this is consistent with client needs and expectations.
For more details on our outlook for the global economy and investment implications over the next five years, read the full Secular Outlook, “Age of Transformation.”
Joachim Fels is PIMCO’s Global Economic Advisor, Andrew Balls is CIO Global Fixed Income, and Dan Ivascyn is Group CIO.
—
Originally Posted on October 20, 2021 – Secular Outlook Takeaways: Age of Transformation
DISCLOSURES
Past performance is not a guarantee or a reliable indicator of future results.
All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Inflation-linked bonds (ILBs) issued by a government are fixed income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Treasury Inflation-Protected Securities (TIPS) are ILBs issued by the U.S. government. Equities may decline in value due to both real and perceived general market, economic and industry conditions. The value of real estate and portfolios that invest in real estate may fluctuate due to: losses from casualty or condemnation, changes in local and general economic conditions, supply and demand, interest rates, property tax rates, regulatory limitations on rents, zoning laws, and operating expenses. 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. Private credit and equity strategies involve a high degree of risk and prospective investors are advised that these strategies are appropriate only for persons of adequate financial means who have no need for liquidity with respect to their investment and who can bear the economic risk, including the possible complete loss, of their investment. Management risk is the risk that the investment techniques and risk analyses applied by an investment manager will not produce the desired results, and that certain policies or developments may affect the investment techniques available to the manager in connection with managing the strategy.
Statements 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 appropriate 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. Investors should consult their investment professional prior to making an investment decision.
Alpha is a measure of performance on a risk-adjusted basis calculated by comparing the volatility (price risk) of a portfolio vs. its risk-adjusted performance to a benchmark index; the excess return relative to the benchmark is alpha. Beta is a measure of price sensitivity to market movements. Market beta is 1.
PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This material contains the opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. ©2021, PIMCO.
Disclosure: PIMCO
All investments contain risk and may lose value. This material is intended for informational purposes only. Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America L.P. in the United States and throughout the world. THE NEW NEUTRAL is a trademark of Pacific Investment Management Company LLC in the United States and throughout the world. ©2023, PIMCO.
Disclosure: Interactive Brokers
Information posted on IBKR Campus that is provided by third-parties does NOT constitute a recommendation that you should contract for the services of that third party. Third-party participants who contribute to IBKR Campus are independent of Interactive Brokers and Interactive Brokers does not make any representations or warranties concerning the services offered, their past or future performance, or the accuracy of the information provided by the third party. Past performance is no guarantee of future results.
This material is from PIMCO and is being posted with its permission. The views expressed in this material are solely those of the author and/or PIMCO and Interactive Brokers is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to buy or sell any security. It should not be construed as research or investment advice or a recommendation to buy, sell or hold any security or commodity. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.
Join The Conversation
If you have a general question, it may already be covered in our FAQs. If you have an account-specific question or concern, please reach out to Client Services.