SUMMARY

  • The sharp correction late last year revealed flaws in the conventional narrative that emerging market (EM) stock losses are always magnified relative to U.S. losses: As U.S. stocks plunged 19.4% from their record high on 21 September 2018 to their 24 December low for the year, EM stocks declined just 6.8%.
  • In our view, current valuations suggest that EM assets could fall less than U.S. assets in a bear market for U.S. stocks, and could even stage an impressive recovery if the U.S. avoids a bear market.
  • Recent regulatory guidance requiring ’40 Act mutual funds to include “interest expense” in their expense ratios has raised questions by investors. However, the fee structures for the All Asset funds, including the fees payable to PIMCO as fund manager, have not changed.

Rob Arnott, founding chairman and head of Research Affiliates, discusses why corresponding declines in emerging markets stemming from a potential bear market for U.S. stocks may not follow patterns seen in the past, while John Cavalieri, PIMCO asset allocation strategist, sheds light on questions about interest expense reporting arising from a recent change in regulatory guidance. As always, their insights are in the context of the PIMCO All Asset and All Asset All Authority funds.

Q: If U.S. stocks enter a bear market, will there be sympathy declines in other areas, such as emerging market (EM) assets?

Arnott: Very likely, in our view. It bears mention, however, that unlike in past cycles, such as 2008–2009, other developed markets and especially emerging markets are priced at deep discounts to U.S. stocks (proxied by the MSCI EAFE, MSCI EM and S&P 500 indices, respectively). Consider emerging markets: With cheap valuations appearing to offer a margin of error on the downside, we believe EM assets could fall less than the U.S. in a bear market and even stage an impressive recovery if the U.S. manages to avoid a bear market.

Take what happened last quarter: As U.S. stocks plunged 19.4% from their record high on 21 September 2018 to their 24 December low for the year, EM stocks fared much better, with a decline of just 6.8%.

Where did this sharp correction leave us? The All Asset suite benefited over this span from a meaningful allocation to what we view as sensibly priced EM stocks.1 Compared with the conventional 60/40 stock/bond mix (proxied by the S&P 500 and the Bloomberg Barclays U.S. Aggregate Bond Index), cumulative losses were 7.88 percentage points lower for All Asset and 10.94 percentage points lower for All Authority (see Figure 1). Of note, the median manager in the Morningstar Tactical Allocation category over the same time span (21 September­–24 December 2018) roughly matched the cumulative 11.36% loss of the 60/40 mix. Our All Asset strategies are designed to deliver downside mitigation and diversification benefits at times when diversification is most needed.

Cumulative returns from the S&P 500’s All Asset and All Asset All Authority Fund

A natural question may follow: Do you believe the U.S. equity bull market – already the longest ever, and one of the largest – is mature (or over), or do you think it has a long way to run? If the former, diversification is more desirable now than it has been in many years.