Highlights from PIMCO Lunch-and-Learn

June 5, 2014  | By Kevin Smith

We held an educational lunch seminar on June 4^th, hosted by PIMCO, and the responses from those who attended have been very positive. We plan on providing more of these in the future for small groups. Here are some highlights…

– Our PIMCO representative shared his firm’s views on the global economy and implications for investors. PIMCO’s main themes are economic productivity below historical averages in the next 3-5 years for a variety of reasons and the persistence of low interest rates in developed markets. We started by spanning the globe…

• U.S. – central banking policy has ‘reflated’ the stock market and the real estate market, but the rest of the economy is recovering quite slowly, which is reflected in the low labor participation rate and very slow growth of real wages.
• Europe – likely to continue experiencing a U.S.-style ‘quantitative easing’ to stimulate the economy.
• Japan – high rates of debt, low interest, and aging demographics are likely compounding factors for slow growth.
• China – addressing the ‘shadow banking’ system and other factors are causing growth challenges.
• Emerging markets – expectations for relatively higher growth rates compared to developed markets, but also closely tied to the progress of developed markets.

-We then heard about PIMCO’s expectations for interest rate policy over the next 5 years. Although predicting the timing and direction of interest rate movements in the near term is not a strategy with high odds of success, the Federal Reserve has adopted the policy of providing enough information to set intermediate term expectations, which can be useful in planning.

• The current federal funds target rate is 0%, the long term average is about 4%, and PIMCO expects that the ‘Neutral’ rate the Federal Reserve will target is likely 2%. A sharp increase in rates would likely bring economic growth to a halt, and stifle the real estate market. The Fed has likely learned its lesson because it tried that after the Great Depression with poor results.
• PIMCO believes this increase will not begin until after quantitative easing (Treasury bond buying) winds down in mid-2015, and increases in interest rates are likely to be gradual.

-PIMCO synthesizes this information into investment implications. Some of the key takeaways from their views that we find useful are…

• The persistence of low interest rates implies negative real returns on cash (after inflation), so don’t hold more cash than you need to.
• The odds of a sustained and sharp increase in interests rates are low, which implies that bond prices are more likely to be fairly stable.
• Positive real returns on bonds with relatively low risk are available in the corporate bond segment and outside of the U.S.
• Expect average annualized returns on stocks and bonds to be lower than historical averages over the next 5-10 years.
• Diversification is as important as ever to capture market returns and consider the use of non-traditional asset categories for meaningful diversification (low correlation to stocks and bonds).
• Central bank policy has caused Treasury bonds to make up a large portion of the aggregate bond market, so market-weighted index bond funds will own more Treasury bonds than most investors will want and cause a drag on returns.