Investment Commentary – July 19, 2023
Year to Date Market Indices as of July 19, 2023
• Dow 35,114 (5.93%)
• S&P 4,573 (19.1%)
• NASDAQ 14,422 (37.81%)
• OIL $76.14 (-5.40 %)
• Barclay Bond Aggregate (1.28%)
• Gold $1,977 (8.06 %)

PIMCO: Bond Market Outlook: Valuations Suggest Potential for Equity-Like Returns With Less Risk

The fixed income market’s massive repricing may offer investors in high quality bonds the potential for equity-like returns with resilience in the face of a likely recession. Here, Richard Clarida, global economic advisor, and Dan Ivascyn, group chief investment officer, review PIMCO’s longer-term market outlook with Kimberly Stafford, global head of product strategy. They discuss why PIMCO is patiently focused on high quality assets, while preparing to pivot over the next few years to more economically sensitive or lower-rated areas of the credit markets.

Stafford: What key forces do you expect to affect economies and markets over the secular horizon of three to five years?

Clarida: We expect more aftershocks after a number of acute tensions disrupted financial markets and set off inflation around the world: a once-in-a-lifetime pandemic and a tidal wave of policy stimulus, the invasion of Ukraine, and escalating U.S.-China frictions. Central banks responded with the sharpest rate increases in 40 years, setting off three of the largest bank failures in U.S. history and the collapse of Credit Suisse in Europe. Taken together, these events may have revealed hidden vulnerabilities in the global financial system.

Stafford: What are the implications for fiscal and monetary policy given high debt levels around the world, tighter credit, and the likelihood of recession?

Clarida: Economic volatility will likely rise in the next five years from the relatively smooth decade before the pandemic. Debt-to-GDP ratios have surged in many countries, limiting the capacity of governments to deploy fiscal stimulus, while central bankers, cognizant of quantitative easing’s (QE’s) contribution to today’s inflation, could offer less support in future downturns. Without massive stimulus to buffer downturns, we believe economic cycles will become more pronounced, with risks skewed to the downside.

Ivascyn: We’ve seen a great deal of credit tightening over the last five quarters. Typically, economies respond to tightening with lags. But with so much consumer and corporate debt locked in at low fixed rates, we think it will take longer this cycle for the effects to be felt. We expect to see policy tightening and bank challenges begin to impact the markets more directly over the next few quarters.

Stafford: What is PIMCO’s outlook for the U.S. dollar?

Clarida: As a reserve currency, the U.S. dollar has tended to be pushed in decade-long waves of overvaluation and then mean reversion. We think this will provide opportunities in the long term to take positions in both emerging- and developed-market currencies against the dollar. In particular, the trend toward friend-shoring global supply chains will likely create winners and losers among countries, currencies, and sectors, and as active managers we find this very attractive.

Stafford: Turning to the commercial real estate (CRE) market, what is your outlook and where do you see opportunities?

Ivascyn: We think commercial real estate is an exciting area for the next five years. As a whole, the commercial real estate market faces steep challenges. But we believe it’s precisely these challenges that will provide the best opportunities to deploy capital in CRE in decades.

In the U.S., regulatory scrutiny, bank failures, and an oncoming recession have pushed traditional lenders to the sidelines, while over the next five years, $2.4 trillion globally in multifamily and commercial real estate loans are scheduled to mature. We believe this will create a range of opportunities for our 300-strong global team of origination, acquisition, and asset management specialists. These include originating new loans to real estate owners needing to finance their upcoming maturities. We will focus on addressing the needs of performing properties that simply have capital structures unsuitable for this higher-rate environment. We anticipate these will offer the ability to extract very attractive terms and covenants, creating tremendous, relatively low-risk opportunities to provide new capital. We also expect increasing opportunities to buy discounted CRE debt from private real estate lenders and banks trying to manage their balance sheets.
In contrast, the outlook for certain commercial real estate sectors, such as retail and office, may be more challenging but not uniform across countries and cities. In the office sector, we expect to see a greater number of distressed sales in the U.S. than in Europe and Asia, where most workers have returned to the office. These sales will, in our view, be concentrated in mid- and low-quality structures, while best-in-class assets should weather the storm. (See our June 2023 outlook, “Real Estate Reckoning.”)

Stafford: Any final thoughts?

Ivascyn: We expect this environment to provide the best opportunities in years for fixed income investing. We’re leveraging PIMCO’s broad and deep global platform across public and private markets to identify opportunities as the credit cycle advances and market excesses are wrung out. In the meantime, high quality bonds pay us to wait as downside risks build in the global economy.

Market-moving news

Inflation relief: A midweek report on U.S. inflation gave the stock market plenty of lift, as the government’s Consumer Price Index fell to an annual rate of 3.0% in June, the lowest level since March 2021. The rate has steadily dropped since peaking at a four-decade high of 9.1% in June 2022. A separate report on Thursday showed easing inflationary pressures at the wholesale level as well.

Earnings liftoff: Earnings season got into full swing on Friday as three major U.S. banks reported second-quarter results, and each one exceeded analysts’ expectations for net income and revenue. However, as of Friday, analysts were forecasting that earnings for all companies in the S&P 500 fell by an average of 7.1% overall, according to FactSet.

Bouncing back: The major U.S. stock indexes climbed around 2% to 3%, regaining ground they had lost the previous week and then some, with the S&P 500 and the NASDAQ reaching their highest levels in 15 months. The NASDAQ’s gain of more than 3% was its best weekly result in four months.

The views presented are not intended to be relied on as a forecast, research or investment advice and are the opinions of the sources cited and are subject to change based on subsequent developments. They are not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investments.

https://www.marketwatch.com/ (Market Indices)
https://www.jhinvestments.com/weekly-market-recap (Around the Web & Upcoming Events)
https://finviz.com/groups.ashx (YTD Performance Chart)
https://www.jhinvestments.com/weekly-market-recap#market-moving-news
https://www.cnbc.com/2023/06/12/stock-market-today-live-updates.html
https://www.pimco.com/en-us/insights/viewpoints/bond-market-outlook-valuations-suggest-potential-for-equity-like-returns-with-less-risk