- During this important annual event, PIMCO colleagues from around the world debate the major trends that will play out over the next three to five years, focusing not on what should happen, but what is likely to happen. Based on the 2012 Secular Forum discussions, we expect three themes to play out: continued policy and political confusion, overly incremental public and private sector responses and, therefore, greater potential for inflection points.
- In terms of regions, the status quo is no longer an option for Europe. The higher probability outcome – though not dominant – is a smaller and less imperfect eurozone. The journey would be bumpy and expensive; and it would require much more responsive and agile policymaking. Thus, the horrible risk of eurozone fragmentation is not de minimis.
- The U.S. will look good relative to Europe, outperforming in terms of growth and financial stability; but, amid political scrimmages rather than grand bargains, concerns will remain about growth, jobs, inequality, debt and deficits. Financial repression will persist as growth proves insufficient to quickly and safely delever segments that are over-indebted.
- Emerging economies, meanwhile, will continue to outpace both Europe and the U.S. over the secular horizon. Their path of expansion and convergence will be more volatile, especially as some countries undertake needed and tricky transitions in their growth models (including China).
- Portfolio implications: Maintain a sizable quality bias for sovereigns and corporate credits; supplement high-quality equity positioning (low financial leverage, high operating margins, and growth exposure) with dividend streams, where possible, as a means of de facto shortening duration; consider real assets to guard against confiscation risk; expand risk management to include cost-effective tail hedging; and evolve strategies, guidelines, dividing lines and mindsets that have guided investing in the past but will likely be challenged in the context of inflection dynamics.
From new normal to paranormal. What if the World is bimodal? Implications on risk, asset allocation.
It wasn’t long ago we were introduced to the “new normal”. This expression by El Erian is now widely used. The new normal, is going paranormal, as those tails are “fatter” than we believe, and guess wgat, it is not a perfect bell curve we follow.
The Trader covered the topic last year, “what if it is a bimodal world?”, but PIMCO’s Gross is out today again , telling us about the new normal. Just a reminder;
- The New Normal, previously believed to be bell-shaped and thin-tailed in its depiction of growth probability and financial market outcomes, appears to be morphing into a world of fat-tailed, almost bimodal outcomes.
- A new duality – credit and zero-bound interest rate risk – characterizes the financial markets of 2012, offering the fat left-tailed possibility of unforeseen policy delevering or the fat right-tailed possibility of central bank inflationary expansion.
- Until the outcome becomes clear, investors should consider ways to hedge their bets, including: maximizing durations, U.S. Treasury bonds that may potentially offer capital gains, long-term Treasury Inflation Protected Securities (TIPS), high quality corporates and senior bank debt, and select U.S. municipal bonds.