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Focus on Tactical Allocation and Relative Value

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Focus on Tactical Allocation and Relative Value 2015 Asset Allocation Outlook Your Global Investment Authority Mihir Worah CIO Asset Allocation and Real Return BEYOND BETA Focus on Tactical Allocation and Relative Value Investors should consider a moderate risk-on posture in multi-asset portfolios given continued global “growth and a low probability of recession in 2015. As the global economy creeps further into a slow and extended business cycle, we expect greater divergence in returns within asset classes and sectors – which means an emphasis on tactical asset allocation, careful ‘bottom-up’ security selection and prudent relative value decisions are going to be critical in 2015. — Mihir Worah | CIO Asset Allocation and Real Return ” 2 2015 ASSET ALLOCATION OUTLOOK PAGE OUTLOOK PAGE 2015 ASSET ALLOCATION INTRODUCTION Investors already weary of a persistent low yield environment complicated by uncertainties — geopolitical tensions, plummeting oil prices, volatile currencies, to name a few — may need to prepare for another challenging year in 2015. From an asset allocation perspective, achieving target returns may be difficult. Not only do we anticipate a tug-of-war escalating between divergent monetary policies and uneven global economic growth, we also observe that 2015 begins with fuller asset valuations than in the recent past amid a persisting low yield environment. Yet, the picture is not entirely bleak: We anticipate a Our Forum conclusions more extended business cycle through the combination At PIMCO’s Cyclical Forum in December 2014, our of a slow-moving Fed willing to chase inflation rather investment professionals from around the world gathered than impede robust U.S. growth and increased policy to discuss how the global macro economy is likely to stimulus from the European Central Bank (ECB) along evolve over the coming year. Following the Forum, our with a continuation of the Bank of Japan’s (BOJ) asset portfolio management leadership team considered how purchases. As long as the odds of a recession remain low, the interplay between macroeconomic fundamentals, we expect various risk assets will deliver attractive valuations, risks and market technicals is likely to impact returns. In particular, we observe the equity risk premium risk and return potential across global asset classes. in the U.S. relative to real rates remains close to its long-run average, reducing the probability of a sharp Bottom line: We believe an overweight to equity risk correction. Nevertheless, there remains significant risk of is still warranted and see pockets of opportunity across increased market volatility as we approach the start of credit sectors. In contrast, we are modestly negative the Fed tightening cycle. interest rate risk, and we have a neutral stance on commodities. In 2015, an emphasis on robust portfolio construction and on exploiting relative value opportunities across asset classes will be more important than the bold “beta bets” that have been sufficient over the past few years. Allocation themes 3 Equities Rates and Credit Real Assets Currencies With interest rates low Given the likelihood of U.S. TIPS and European As central bank policies and some years still the Fed hiking interest inflation-linked bonds diverge further, we ahead for the business rates later in 2015, we are attractively priced expect continued cycle to run its course, favor fixed income inflation hedges. We strengthening of the current equity valuations sectors that are less maintain a neutral U.S. dollar and further appear justified. We sensitive to rising rates. stance on commodities weakening of the euro favor European and European peripheral but are bearish on gold. and the Japanese yen. Japanese equities (on a debt, U.S. non-agency We believe oil prices are We find select currency hedged basis) mortgage-backed hovering near bottom, opportunities in and find attractive securities, and select EM though bouts of emerging currencies, in investment opportunities debt sectors offer volatility may produce particular the Indian in emerging Asia. attractive value. extreme outcomes. rupee and Mexican peso. 2015 ASSET ALLOCATION OUTLOOK PAGE OUTLOOK PAGE 2015 ASSET ALLOCATION MACROECONOMIC OVERVIEW PIMCO’s top-down macroeconomic forecasts form the backdrop for the asset allocation views that are expressed in our multi-asset portfolios. These macro views originate from our Secular and Cyclical Economic Forums, during which investment professionals from all our global offices gather in Newport Beach to discuss the outlook for economies and markets. Outlook for major global economies In Japan, we expect growth to rebound due to bold PIMCO expects global growth to accelerate from around action by policymakers as well as declining oil prices and 2.50% (year-over-year) in 2014 to 2.75% in 2015. We a depreciating yen. However, the private sector still must believe the majority of this improvement will come from confront major secular and structural headwinds. supply-driven declines in oil prices. Acceleration in the Among other regions, we expect to see growth in velocity of money, driven by the transfer of incremental Europe of around 1.0% in 2015, higher than in 2014 petrodollar cash flows from producers to consumers, is but still weak. In China, we expect growth of around also supportive of higher global growth this year. 6.5%, moderating downward as China continues its Across key global economies, we expect growth in attempts to transition to a growth model (and growth 2015 to be highly divergent, though overall somewhat rate) that is less reliant on credit expansion and investment. stronger than in 2014. In particular, we expect U.S. and Cyclical inflation outlook Japanese growth to pick up, reaching levels of around Declining oil prices are likely to have a clear downside 3.0% and 1.5%, respectively. Dr. Ben Bernanke, the impact on global inflation data this year. In most guest speaker at the December Cyclical Forum, affirmed developed economies, headline inflation will likely PIMCO’s view that the outlook for the U.S. economy become negative in the early part of 2015, only to in 2015 is incrementally positive, reflecting improving bounce back into positive territory as we go into late household finances and confidence as well as increasing 2015 and early 2016. Core inflation (excluding food and evidence that the economic recovery is becoming energy) will likely remain around current levels of 1.6% self-sustaining and broad-based. on a year-over-year basis. 4 Our discussion of global rates and risk assets was anchored by our secular New Neutral “thesis. However, we concluded that this longer-term outlook for lower neutral policy rates is now largely priced into the markets. — Daniel J. Ivascyn | Group Chief Investment Officer 2015 ASSET ALLOCATION OUTLOOK PAGE OUTLOOK PAGE 2015 ASSET ALLOCATION ” MACROECONOMIC OVERVIEW GROWTH OUTLOOK FOR 2015 (GDP RANGE) UNITED STATES UNITED KINGDOM CHINA 2.75% to 3.25% 2.5% to 3.0% 6.0% to 7.0% EUROZONE JAPAN BRIM 0.75% to 1.25% 1.25% to 1.75% 1.5% to 2.5% BRIM is Brazil, Russia, India, Mexico REAL GDP HEADLINE INFLATION FORECAST CURRENT* Q4’14 – Q4’15 CURRENT* Q4’14 – Q4’15 UNITED STATES +2.4% +2.75% to +3.25% +1.7% +0.75% to +1.25% EUROZONE +0.8% +0.75% to +1.25% +0.4% +0.5% to +1.0% UNITED KINGDOM +3.0% +2.5% to +3.0% +1.3% +1.0% to +1.5% 5 JAPAN -1.2% +1.25% to +1.75% +1.0% +0.75 to +1.25% CHINA +7.3% +6.0% to +7.0% +2.1% +1.5% to +2.5% BRIM** +1.8% +1.5 to +2.5% +6.7% +5.25% to +6.25% WORLD*** +2.5% +2.5% to +3.0% +2.1% +1.5% to +2.0% *Current data for real GDP and inflation represent four quarters ending Q3 2014 **BRIM is Brazil, Russia, India, Mexico ***World is weighted average of countries listed in table above Source: Bloomberg, PIMCO calculations 2015 ASSET ALLOCATION OUTLOOK PAGE OUTLOOK PAGE 2015 ASSET ALLOCATION ASSET ALLOCATION THEMES FOR MULTI-ASSET PORTFOLIOS Investors should consider a moderate risk-on posture in multi-asset portfolios given continued global growth and a low probability of recession in 2015. As the global economy creeps further into a slow and extended business cycle, we expect greater divergence in returns within asset classes and sectors — which means an emphasis on tactical asset allocation, careful “bottom-up” security selection and prudent relative value decisions are going to be critical in 2015. Several broad themes will be reflected in PIMCO’s On spread sectors, we believe investors should consider multi-asset portfolios in 2015. A moderate risk-on selective overweights, carefully surveying individual posture means we expect to maintain an overweight credits in non-agency mortgage-backed securities, to global equities. Within global equity market investment grade, high yield and emerging markets regions, we favor non-U.S. equities, in particular where attractive spreads can offer diversified sources of European and Japanese equities (both on a hedged portfolio carry, with careful credit analysis helping to basis) and select emerging Asia equities. identify strong credits and avoid defaults. On interest rates, we continue to believe in PIMCO’s Turning to real assets, we maintain a neutral stance secular New Neutral hypothesis, in which average on commodities: The drop in commodity prices and the policy rates are set well below the levels that prevailed resulting curtailment of production means supply and before the global financial crisis. However, this longer- demand will move back into balance over the course term outlook for lower neutral policy rates is now of 2015. Within commodities we are neutral oil, favor largely priced into the markets. What is probably not industrial versus precious metals and have a negative yet fully reflected by the rate markets is the view that view on the agricultural commodities.
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