Thoughts from PIMCO Due Diligence Event

Earlier this month, President Neil Hoyt, CFP® attended a due diligence conference at Pacific Investment Management Company (PIMCO) headquarters in Newport Beach, California. The conference consisted of various presentations from PIMCO fund managers and strategists. The primary focus of the event was the discussion of key investment opportunities as well as noteworthy market risks. Below are Neil’s three major takeaways from the due diligence event.

PIMCO believes bonds will meaningfully outperform stocks over the next 12 months.

Rich stock valuations, negative earnings growth, and restrictive monetary policy – not the most cheering cocktail for stocks in the near-term. PIMCO conducted an internal analysis of asset class returns under various scenarios of Fed policy. The results indicate an increased likelihood of Treasuries outperforming stocks over the next 12 months.

“…history suggests 12-month returns following the final rate hike could be flat for 10-year U.S. Treasuries, while the S&P 500 could sell off sharply. If the Fed pivots more quickly and cuts rates within six months of its last hike, then history suggests equities could rally in the 12 months following the final rate hike – but bonds could still outperform equities.”

With a high probability of a recession in the US, PIMCO notes how bonds can help bolster portfolios during turbulent economic times. It’s worth noting, even though PIMCO’s base case is a US recession in 2023, data suggests recessions that begin from periods of elevated savings (such as 2023) are milder than average. In summary, PIMCO favors bonds as an allocation due to their diversification and upside potential.

Within fixed income, PIMCO likes municipal bonds and mortgage-backed securities (MBS).

One of externalities of the current banking crisis is that it’s made municipal bonds and mortgage-backed securities relatively cheap. Silicon Valley Bank maintained municipal holdings valued at over $7 billion – those holdings are set to be liquidated and this will put pressure on municipal bond prices. As for MBS, PIMCO believes QT is creating artificial supply. Couple this with an uptick in new issuance and you receive a lot of downward price pressure. The spread between the 30-year MBS and 30-year treasury remains at historically high levels. Additionally, there is a demographic need for housing. Since 2008, the US has not added enough to housing supply to make the MBS market unattractive.

The US Dollar is set to weaken, PIMCO believes non-dollar holdings such as foreign bonds and stocks, are a great way to benefit for US Dollar headwinds.

Drivers of the US Dollar decline include falling inflation and waning monetary policy volatility. Non-dollar holdings benefit from a weaker US dollar. It’s no secret that foreign stocks have underperformed US domestic stocks over the last two decades. However, the environment of higher rates favoring the US dollar over other global currencies, is quickly fading. Over the intermediate term, this will become a major tailwind for non-US assets. PIMCO highlighted Emerging Market countries along with continued strength in the commodity market. Both are variations of the same theme, as the business cycle of emerging economies are closely tied to commodity prices.

Closing thoughts

PIMCO isn’t shying away from the difficult datasets. Whether it’s the labor market, inflation, or stress in the banking sector - uncertainty will provide opportunities within fixed income. Cash and low duration fixed income worked well in 2022, but we now find ourselves at an inflection point. Following one of the most aggressive Fed rate hiking cycles in US history, PIMCO believes adding duration to your bond portfolio is a prudent investment decision.

Certain sections of this commentary contain forward-looking statements that are based on reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. All indices are unmanaged and investors cannot invest directly into an index.

This material is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Investments are subject to risk, including the loss of principal. Some investments are not suitable for all investors, and there is no guarantee that any investing goal will be met. Past performance is no guarantee of future results. Talk to your financial advisor before making any investing decisions.

Bonds are subject to availability and market conditions; some have call features that may affect income. Bond prices and yields are inversely related: when the price goes up, the yield goes down, and vice versa. Market risk is a consideration if sold or redeemed prior to maturity.

Municipal bonds are federally tax-free but may be subject to state and local taxes, and interest income may be subject to federal alternative minimum tax (AMT).

The main risks of international investing are currency fluctuations, differences in accounting methods; foreign taxation; economic, political or financial instability; lack of timely or reliable information; or unfavorable political or legal developments.