PIMCO's Cyclical Outlook:Aftershocks of Financial Dislocation

In its latest Cyclical Outlook,composed at an investment forum by its international cadre of financial experts,PIMCO portrayed a world that is still very much feeling,and being influenced by,the shock waves from the global financial crisis.
Notwithstanding the recent calmer tone in the markets,wrote PIMCO's Joachim Fels,Global Economic Advisor,and Andrew Balls,CIO Global Fixed Income,in a PIMCO Insight,the weaker global growth economic momentum at the end of 2015/start of 2016 and the significant,though temporary,tightening in global financial conditions in January/February meant that 2016 economic growth and inflation would likely come in at or below the ranges they had forecast in December for most major economies.*
Consequently,the investment forum lowered PIMCO's forecast for calendar year 2016 global real GDP growth by a quarter-point,to a range of 2-2.5%.Actual global GDP growth was 2.8 in 2014 and 2.6 last year;their forecast sees the slowdown continuing.*
Wherever one looks around the globe,PIMCO believes,nominal and real GDP growth and,therefore,interest rates are likely to stay well below historical norms,very much in line with their New Normal concept of a world economy transformed after the global financial crisis of 2008.The New Normal,Fels and Balls explain,is characterised by both weak potential output and a lack of aggregate demand,reflecting high debt levels and an excess of global desired saving over investment-the global savings glut.This continues to provide significant headwinds for growth,not only on their secular 3-5 year horizon;but also over the cyclical 6-12 month timeframe.It underpins their expectations for a low "neutral" central bank policy-along with The New Normal,they have described The New Neutral,referring more explicitly to central bank policies converging to lower neutral rates than in past economic cycles.*
PIMCO puts the probability of a US/global recession over the next 6-12 months as at most 20%.This is because,right now,none of the typical signs of imminent collapse are flashing:no over-consumption;no over-investment;no over-heating;and no monetary overkill.In short,they expect this expansion to last,lackluster though it be.

Global Debt and the Risk to Capitalism

The Federal Reserve Open Market Committee issued its interest rate decision Wednesday afternoon,deciding to leave rates unchanged for now,and anticipating only two rate hikes this year,rather than four.They are not actively considering negative interest rates,unlike the European Central Bank,which has just implemented them.*
Markets and central banks globally are beginning to realise that there are negatives to negative interest rates,responded Bill Gross of Janus Capital Management,portfolio manager of the Janus Global Unconstrained Bond Fund and co-founder of PIMCO.It's a more dovish Fed.The Fed is still way above the market.Treasuries are fully priced at these levels.The Fed is connected to the stock market,but I don't think they're responsive to rates being at zero.It's a negative for the finance industry,for pensioners and for savers.They can't earn as much as they should.*
I think,to a certain extent,capitalism is at risk.It doesn't break down,but at the margin,it's hindered and it's hampered.The long term effect basically hampers investment by institutions like insurance companies.*
I think the Fed has an historical sense that Fed Funds should be at 3 or 4%.The real problem is,the tremendous amount of debt in the global markets.When debt gets up to a substantial level,things can de-lever.It's debt that has come to the forefront the past several years in the global economy,and that's what we need to worry about.*
An economy can't grow very fast if wages can't grow more than .6%.I think TIPS are a decent value,to the extent the Fed will reach their 2% inflation target.*
iShares TIPS Bond ETF (TIP),Janus Global Unconstrained Bond Fund;A (JUCAX)

Leading Economic Advisor Says Barbells Are Best Portfolios

Mohamed El-Erian,chief economic advisor at Allianz,says he has a barbell investment strategy for the current conditions.It consists of cash and then more high risk exposures to startups and hedge funds,because the most highly trafficked part of the risk-return is the public markets.Why? Because the Fed has been pushing everybody to the public markets,pushing up market prices.So if you look at long-term valuation,it makes more sense to become bar-belled and reduce your exposure to the most heavily trafficked and artificially lifted asset prices.That's why there's this barbell of cash and then hedge funds,startups and illiquids-and that's what a lot of investors are starting to do,by the way.
As long as we don't get the Fed fundamentals,we are more at risk of not validating the higher asset prices.At some point,you have to hand off to investing in equipment and hiring.I still think the Fed is going to raise rates in September.They're going to focus on this,the loosest tightening the Fed has ever done.*
Will the ECB pull the plug on Greece? No,because no one wants to go down in history as having done it.My greatest worry is,we get an accident in that world.The chance that Greece is pushed out of the Euro-zone is quite material.The fundamentals all call for a stronger dollar.In the short term,a Greek exit will shock the market.Long-term,it doesn't matter much.Take equity exposure to Europe,but not euro currency exposure,Mr.El-Erian advised.*
Mohamed El-Erian was born in Cairo,Egypt.He was manager of the Harvard Endowment,then co-CEO and co-CIO of PIMCO with Bill Gross before they had a falling out.Eventually,Gross himself was fired by the company he co-founded and went over to Morgan Stanley.*
Morgan Stanley (MS),Allianz SE SP/ADR (AZSEY)

Searching For Yield:Bank Loans,Gold and IBM

We think ultimately rates are going to be heading higher,said Mark Kiesel,PIMCO CIO and co-manager of the firm's iconic income fund,the Total Return Fund.You're better off investing in bank loans at 4-5% yield.You're not going to get that with bonds today.It's also a sign of global disinflation.With bank loans,you're investing in a structure that protects you.MGM and Hilton are offering 4-5% on bank loans.
As of 9-26,we've outperformed about 90% internationally at the Total Return Fund.TIPS,or Treasury Inflation-Protected Securities,are very cheap,favouring international markets like Brazil and Mexico.We have a great story at Total Return Fund.
Morningstar Associates gives the Total Return Fund three out of four stars and considers it to be world class.
Bank loans in the form of mortgage-backed securities are commonly in the portfolios of income funds,including the Total Return Fund.*
Most of the damage done by the Swiss central bank,which of a sudden lifted a three-year-old cap on the Swiss franc, probably occurred in retail debts.I don't think there will be anything untoward that happened to US banks.I think it just causes greater disrespect for central banks generally,said Dennis Gartman,editor of The Gartman Letter.
I've been long gold and short euros,and that's been very beneficial.I see no reason to think that strong gold's going to change.The Swiss move is going to be detrimental to their currencies and strong to gold.*
IBM reported earnings per share of 5.81,in line with the estimate.Revenue was 24.11 billion,falling a bit short of the 24.77 billion estimate.Currency fluctuations and divestitures hurt their revenue.I think it's a step in the right direction,said Daniel Ives of FBR Capital Markets.Can this company succeed in the cloud?The outlook going forward is really the elephant in the room for investors.Given the playbook,it's about IBM giving investors comfort in the cloud transition.*
PIMCO Total Return Fund Class A(PTTAX),International Business Machines(IBM),Market Vectors Gold Miners ETF(GDX)

What To Watch For in the Market

I think the economy is certainly improving,said Jack Ablin,Vice President and Chief Investment Officer of BMO Capital Markets.That being said,we do have European problems that could affect the market.I am watching credit spreads;they are starting to widen.We have to see how that plays out on the credit side.*
I think Bill Gross leaving the money management firm PIMCO may have moved the market.The fact is,banks' trading desks have been whittled back.I do think there was an outflow of bonds into the marketplace,Mr.Ablin added.*
Energy stocks to watch if the Keystone Pipeline wins approval:
Trans Canada(TRP)
Canada Natural Resources(CNQ)
Valero(VLO)
Quarta Services(PWR)*
We're watching a lot of measures,said Jonathan Krinsky,Chief Market Technician at MKM Partners.There's been a sustained pressure on the energy sector.There's a little more upside,maybe one or two percentage points,in the S&P;then we're getting into some real resistance.
It's an outlier market.There's been about seven times in the last 50 years where we've seen a streak this long.It's difficult to extract too much from this data.We haven't seen many streaks like that.It's more interesting than not,and we should keep watching,Mr.Krinsky advised.

Bond Market Impact:The Implications of Rising Rates

The recent bond sell-off and concomittant rise in interest rates present both challenges and opportunities.
I think we're gonna see a slowing in housing,said Bliss Morris,CEO of First Financial Network.Rising rates could certainly affect newer borrowers.Those still involved in renting could have some trouble buying a home.
California is doing better,the sand states of Arizona,Florida and Nevada,but secondary and tertiary markets could be in trouble.Our community banks are suffering from regulations and have not totally sold off their non-performing assests.
The next opportunities could be in the Euro-zone,with its many foreclosed properties.I don't think they've totally stabilised.They face some challenges with cultural and linguistic differences.
We do think the Treasury market offers value here,said Mark Kiesel,managing director and portfolio manager at PIMCO.We see a much weaker economy,and so we see value.We just don't see the economy generating jobs growth.There's a lot of consumer debt and unemployment is structurally high.
We're going through an unwinding of risk,creating volatility,but over time,the Fed will take another point of view and rates will go back down,Mr.Kiesel projected.
Mark Kiesel was Morningstar Associate's 2012 Fixed Income Manager of the Year.

Portfolio Management:The Need For Income Now

We've transitioned to an emergency need for income,said Rick Rieder,Chief Investment Officer of Fundamental Fixed Income at BlackRock.Rates are gonna be low for a long time.To get any real income,you have to take risk at levels that are uncomfortable.
Central banks are crowding out investments at a record level.You create a portfolio rebalancing act that is profound.We live in a delevering world.You'll create bubbles like we had in prior decades if it goes on for too long.
Maybe there will be no tapering of Fed policy until 2014.Because you're distorting the interest rates so low and lengthening the portfolio,you're creating potential risk in the fixed income portfolio higher than in equities.Tactical short term,we've taken some interest rate exposure;longer term,loans and structured products without a lot of interest rate risks,such as CMBS,collateralised mortgaged-backed securities.
We think the growth of the real estate business has some real durability to it.People underestimate what a big deal it is.You have an environment of liquidity today.It's part of what will keep the real estate market in strong shape.
The delevering in Europe is gonna go on for years.
It's very hard to generate yield when the 10 year Treasury is at 1.50%,Mr.Rieder pointed out.Central bank policies are causing a haircut for investors,PIMCO co-CIO Bill Gross agreed.
People are excited about the equity market,yet anxious about the artificiality of central bank assistance,his colleague Mohamed El-Erian added.If these prices are not validated by data,they will look very artificial.
BlackRock,Inc(BLK)

Where The Financial Problem Is-and how to deal with it

The problem is,central banks don't have the right tools,according to Mohamed El-Erian,CEO of PIMCO.The best they can do is provide a bridge,but it has to be a bridge to somewhere.
The politicians aren't doing enough.People are refusing to invest because of the uncertainty.The Fed has been the investor's best friend,supporting valuations and markets.
Our baseline is 1.5% growth-plus or minus 0.5%.If politicians don't get their act together,that would push us into recession.If nothing happens,that will unambiguously throw us into recession.
The sooner,the better.Already businesses are pulling back,investing less.
Be very careful.Focus on sovereigns and companies with strong balance sheets and can give back cash to shareholders,Mr.El-Erian counseled.
Mohamed El-Erian is also co-Chief Investment Officer at PIMCO along with founder Bill Gross.The company now offers a wide range of both active and passive exchange-traded funds,as well as mutual funds.

Euro Debt Crisis Means Cheap Assets

Spain is gonna be one of the two or three biggest markets for distressed assets,said Russell Platt of Forum Partners Investment Management.It could take 7-10 years in the courts to take control of the assets.There are about 140 billion euros of distressed assets available in Spain.
Germany is the biggest market for distressed assets-about 200 billion euros' worth.It's a chance to buy real estate cheaper.We see commercial properties at 50-60 cents on the dollar in the UK.
In the US,we're buying REITs mostly and mortgage-backed securities.We also like homebuilders.
PIMCO is one of the biggest buyers of distressed European assets.DIC Asset AG is a fund that buys distressed office properties in Germany.
Forum Partners is a global real estate investment management firm.It has 6 billion dollars of assets under management for institutions and family offices.With offices from London to Beijing and Santa Fe,it has invested in 17 countries in Europe and Asia.
DIC Asset AG(DAZ:Xetra),iShares Barclays CMBS Bond Fund(CMBS)

An Edgy Era

We are entering a world of higher inflationary pressures,Mohamed El-Erian said.The Pimco executive thinks we will witness a period of continued shrinkage of balance sheets.The economy will shift away from traditional drivers of growth.Expect a significant realignment of the financial sector over the secular horizon.There is no perfect response by the Federal Reserve;there are no easy policy solutions.Inflationary pressures are complicating the global outlook,Mr.El-Erian reflected.

El-Erian:A Quiet Voice

Mohamed El-Erian,an executive with Pimco,feels it is a time of great tumult and great opportunity.The credit crisis has morphed into an economic crisis.You can't just take the financial system and recapitalize it.There are major bargains out there,but you've got to be careful.You need support,because it is a bumpy time.Remain diversified;keep a cash cushion.It's better to be later in this market,Mr.El-Erian advised.