Hear expert insights into investing for retirement from the Morningstar Investment Conference 2015, in our Special Report.
“There’s no recession on the horizon,” said bond giant PIMCO’s Mihir Worah at the recent Morningstar Investment Conference, referring to the developed economies and other major economies including India and China. The CIO of Asset Allocation and Real Return at PIMCO noted Russia and Brazil as exceptions, but confirmed that the fund house doesn’t expect anything more disappointing than a very low, muted recovery in the developed world over the next 12-18 months.
PIMCO forecasts GDP growth of 2.5% for each of the UK and the US, 1.5% for the EU and 6.5% for China in 2015 – “nothing to get excited about,” in Worah’s words, but a stable enough backdrop to identify specific investment opportunities.
The major drivers of asset prices over the next few years will be central bank policy, Worah told the conference audience of 500 financial advisers. “It’s not just bond prices that are dictated by interest rates, rates are also the backdrop for the pricing of any long-term assets,” Worah said, adding that we therefore shouldn’t expect to see valuations going back to the abnormal levels of the ‘70s, ‘80s or early ‘90s. “If we’re right that long term rates are likely to remain low, that supports valuations across asset class and across stock markets” he said.
Prior to 2007, all central banks converged – raising rates together, and dropping rates together. But now we’re seeing a divergence, with Japan and the US Fed pushing for policy that raises rates, while the EU and UK are set to keep rates flat for 2016 and into 2017, according to Worah.
Current bond market valuation levels appear elevated on a historical view, but not overvalued. Meanwhile, if interest rates stay low, the higher equity multiples will stay high too, the asset allocation expect said.
Five-year Expectations
Over the next five years, PIMCO expects cash to achieve a nominal annual return over the period of around 2%, rising from zero as the Federal Reserve starts to hike rates over the next two years.
For developed world bonds, PIMCO also sees a return of 2%, explaining why the firm’s view is for an underweight holding in the bond market relative to what would be considered a normal long-term allocation. That said, bonds still carry out rthe important role in investor portfolios of providing protection against equity market turbulence. Within the government bond market, PIMCO’s portfolios are notably underweight in US government notes, neutral on core Eurozone government debt, neutral also on Japanese debt, and very slightly overweight in emerging markets bonds. Such a position is designed to protect assets in the case that PIMCO’s theory of no developed-world recession in the next few years turns out to be misplaced.
Amongst corporate credit, PIMCO is overweight on global credit as a whole, with a slight overweight holding allocated to securitised debt. Worah said the firm likes bonds that are backed by real estate in the US as it believes home prices will rise by 6-8% on average across the nation over the next two years. Elsewhere, PIMCO is slightly underweight investment grade corporate bonds, slightly overweight high-yield bonds and very marginally overweight on emerging market credit.
Turning to equities, over the next five years the investment houses’ outlook is for annual growth of 4.5% but PIMCO is notable underweight on US equities, while overweight on European, Japanese and Chinese H shares. “A month ago we got defensive on equity markets and run a neutral position on equities as a whole,” Worah said, “but we’re building a small position in Korean equities, though we don’t like the rest of the emerging markets.”
For a balanced portfolio containing 60% in global equities and 40% in developed world bonds, Worah said the expectation was that average annual returns of 3.5% could be achieved over a five-year period.
Last but not least, Worah explained the firm’s real assets view: “We’re neutral on commodities, overweight on inflation-linked products, neutral on REITs and very marginally overweight on gold.” One real asset that PIMCO is particularly keen on is inflation-linked…everywhere in the world except the UK.
“Underlying inflation is likely to start rising across most markets,” Worah said, “but you must understand that for any international investor a UK inflation-linked investment is one of the most expensive assets in the world, with RPI likely to be 1.0-1.5% for the rest of 2015, rising to just 2.0-2.5% longer term.”
