Joachim Fels, Managing Director at PIMCO, believes that investors and policymakers will likely face a radically different macro environment over the next five years as the New Normal decade of subpar-but-stable growth, below-target inflation, subdued volatility, and juicy asset returns fades into the rearview mirror. In this context, active investors capable of navigating a difficult environment are best positioned for opportunities.
“What lies ahead is a more uncertain and uneven growth and inflation environment in which overall capital market returns are likely to be lower and more volatile”, he explained during the presentation of the latest Secular Outlook, “Age of Transformation”. In this report, PIMCO discusses ongoing disruptors as well as trends will drive a major transformation of the global economy and markets.
Both Fels and Andrew Balls, CIO Global Fixed Income, pointed out that this transformation should yield good alpha opportunities for active investors capable of navigating the difficult terrain. The asset manager already highlighted in 2020 that the COVID-19 pandemic would serve as a catalyst for accelerating and amplifying four important secular disruptors: the China–U.S. rivalry, populism, technology, and climate change. “Developments over the past year have reinforced those expectations”, they say.
Three trends: green, technology and equality
In the firm’s view, these four disruptors, along with the three secular trends, will have important implications for economic and investment outcomes in the Age of Transformation. The first one is the transition from brown to green. “Efforts to achieve net zero carbon emissions by 2050 mean that both private and public investment in renewable energy will be boosted for years to come. Of course, higher spending on clean energy is likely to be partly, but not fully, offset by lower investment and capital destruction in brown energy sectors such as coal and oil”, commented Fels.
In his opinion, during the transition there is a potential for supply disruptions and sharp rises in energy prices that sap growth and boost inflation. Moreover, as the process creates winners and losers, there is a potential for political backlash in response to job losses in brown industries, higher carbon taxes and prices, or carbon border adjustment mechanisms that make imports more expensive.
The second transformation is the faster adoption of new technologies: “Data so far show a significant rise in corporate spending on technology. Similar increases in investment in the past, e.g., during the 1990s in the U.S., have been accompanied by an acceleration in productivity growth. Yet it remains to be seen whether the recent surge in tech investment and productivity growth is a one-off or the beginning of a stronger trend”.
In this sense, Fels believes that digitalization and automation will create new jobs and make existing jobs more productive. But it will also be disruptive for those whose jobs will disappear and who may lack the right skills to find employment elsewhere. As with globalization, he highlighted that the dark side of digitalization and automation will likely be rising inequality and more support for populist policies.
The third trend has to do with the heightened focus by policymakers and society at large on addressing widening income and wealth inequality and making growth more inclusive: “For example, anecdotal evidence suggests that in many companies, the balance of power in the employer-employee relationship has started to shift from the former to the latter, thus improving workers’ bargaining power. It remains to be seen whether this trend continues or whether work from home with the help of technology eventually allows companies to outsource more jobs to cheaper domestic and global locations, thus preserving or even increasing employers’ bargaining power”.
Investment conclusions
PIMCO believes that the “Age of Transformation” will present more difficult terrain for investors than the experience of the New Normal over the past decade; but that it will also provide good alpha opportunities for active investors who are equipped to take advantage of what they expect to be a period of higher volatility and “fatter tails” than the common bell curve distribution.
“Higher macroeconomic and market volatility is very likely to mean lower returns across fixed income and equity markets. Starting valuations – low real and nominal yields in fixed income markets and historically high equity multiples – reinforce the expectation”, highlighted Balls.
In their baseline, they expect low central bank rates to prevail and anchor global fixed income markets. “Although we see upside risks to interest rates over the short term as economies continue to recover, over the secular horizon we expect rates to remain relatively range-bound. We expect lower but positive returns for core bond allocations”, he added.
Lastly, while a sustained period of high inflation is not their baseline outlook, they continue to think that U.S. Treasury Inflation-Protected Securities (TIPS), as well as commodities and other real assets, “make sense as hedges against inflation risks”.
For Funds Society, Madrid
