EXECUTIVE SUMMARY

  • Our baseline outlook is for lackluster global growth, low inflation, and New Neutral interest rates over the next three to five years. A shallow recession followed by a sluggish recovery remains likely.
  • Risks to the outlook are significant, however, as China, evolving populist movements, aging societies, technological change, financial market vulnerability, and climate instability all have potential to disrupt economies and markets.
  • These risks, combined with stretched valuations, have created a difficult investment environment that we believe favors caution, flexibility, and liquidity over yield-chasing. That said, a disruptive market atmosphere should also provide attractive opportunities for active investors.
  • Equity markets may see lower absolute returns and more volatility. We prefer U.S. duration as a hedge against declines in risk assets and continue to view U.S. agency mortgage-backed securities as a relatively stable and defensive potential source of income. We will pursue high-conviction ideas in corporate credit while remaining cautious on overall credit beta.

In early May we gathered our global team of investment professionals in Newport Beach for PIMCO’s 38th annual Secular Forum. With input from invited speakers (see Our Process section, below) as well as our Global Advisory Board and other consultants, we zoomed in on several key secular drivers that have the potential to significantly disrupt the global economy, financial markets, and investors’ portfolios over the next three to five years, and discussed how investors can deal with disruption. Here’s what we concluded.

What's priced in?

Any consideration of the outlook for macro and markets has to start from what asset markets are currently pricing in regarding future growth, inflation, and policy. And so, going into PIMCO’s annual Secular Forum, we observed that our long-standing New Normal (2009) / New Neutral (2014) thesis of lackluster growth, low inflation, and New Neutral interest rates appears to be fully priced in: Short rates and inflation are expected to stay low, yield curves are flat, credit spreads are tight, equities are fully valued, and volatility is at rock-bottom levels.

Thus, despite occasional “Rude Awakenings” caused by trade conflicts, China’s slowdown, and European politics, investors seem to have comfortably arrived in a New Neutral world where nothing can possibly go wrong for long, as central banks stand ready to jump in if needed. The latest case in point was the Federal Reserve’s triple dovish pivot on rates, the balance sheet, and its inflation strategy in January, which led to a rebound in risk assets after the sell-off late last year.