Pimco’s global CIO on the macro outlook, why resilience matters, navigating the rate cycle, China, and more.
This is Dan’s second appearance on The Long View, his first taking place back in May 2019, when Christine Benz and I interviewed him for the podcast. Dan is Pimco’s group chief investment officer, a managing director, and a member of the firm’s executive committee and investment committee. He is also lead portfolio manager for the firm’s Income, Credit Hedge Fund, and Mortgage Opportunistic strategies, and a portfolio manager for Total Return strategies. Morningstar named Dan Fixed-Income Manager of the Year for 2013. Dan earned his bachelor’s degree in economics from Occidental College and his MBA in analytic finance at the University of Chicago Booth School of Business. We conducted this interview at Pimco’s headquarters in Newport Beach, California.
Background
Pimco Income Institutional Fund
Pimco Credit Opportunities Bond Institutional Fund
Pimco Mortgage Opportunities and Bond Institutional Fund
“Dan Ivascyn: Building a Portfolio to Bend but not Break,” The Long View podcast, Morningstar.com, Sept. 11, 2019.
Secular Outlook
“The Aftershock Economy,” by Dan Ivascyn, Andrew Balls, and Richard Clarida, pimco.com, June 6, 2023.
“Income Fund Update: Capitalizing on the Global Opportunities in Fixed Income,” by Dan Ivascyn and Esteban Burbano, pimco.com, May 13, 2024.
“What to Expect When You’re Expecting Rate Cuts,” video interview with Dan Ivascyn and Kimberley Stafford, pimco.com, April 25, 2024.
“Pimco’s Ivascyn Warns of ‘Too Much Enthusiasm’ on 2024 Rate Cuts,” by Michael Mackenzie, Bloomberg.com, Nov. 15, 2023.
“Income Fund Update: Compelling Yields Today, Potential Price Appreciation Tomorrow,” by Dan Ivascyn and Esteban Burbano, pimco.com, Feb. 20, 2024.
“Capitalizing on Market Shifts in 2024,” video interview with Dan Ivascyn and Kenneth Chambers, pimco.com, January 2024.
“Bonds Look Attractive Compared With Cash, Equities,” by Dan Ivascyn, pimco.com, February 2024.
“Yield Matters: A Fresh Look at Core Bonds,” video interview with Dan Ivascyn, Mohit Mittal, and Richard Clarida, pimco.com, May 2024.
“What Higher-for-Longer Rates Mean for Investors,” video interview with Dan Ivascyn and Kimberley Stafford, pimco.com, February 2024.
“Opportunity in Focus: Private Credit,” video interview with Dan Ivascyn and Kenneth Chambers, pimco.com, January 2024.
“Navigating Uncertainty With Alternative Investments,” video interview with Dan Ivascyn and Richard Clarida, pimco.com, December 2023.
Jeff Ptak: Hi, and welcome to The Long View. I’m Jeff Ptak, chief ratings officer for Morningstar Research Services.
I recently had the opportunity to interview Dan Ivascyn in a taped video shown at the Morningstar Investment Conference, All-Digital Day that was put on by my colleagues in Sydney, Australia.
Though Dan and I covered a lot of ground related to the global economy and markets, note that a few questions pertain specifically to Australia and monetary policy of the RBA, which stands for Reserve Bank of Australia. Without further ado, here’s my conversation with Dan Ivascyn.
Dan, welcome to the Morningstar Investment Conference, and thanks so much for joining us in this chat.
Dan Ivascyn: Thanks. It’s great to be here. I look forward to spending some time talking about the economy and markets.
Ptak: I wanted to start at a very high level, which is your secular outlook. You published the most recent version. I think it was around this time last year, if I’m not mistaken. And in it, you stated with the era of volatility-suppressing policies possibly over. You expected heightened volatility and risk to global growth. And in fact, we’ve seen continued volatility in global rate markets, as well as unsynchronized disinflation patterns across economies. So curious to get an update how your views might have evolved since you published that outlook around this time last year.
Ivascyn: I think timing is pretty good in that we just had our secular forum a couple of weeks ago, where again, we brought in some outside experts, got the whole group together, mostly here in Newport Beach, but also using that VC technology we all figured out during the unfortunate covid period, and we talked about the outlook for economies and markets over the next five years. So, we’re in the process now of doing smaller breakouts. And in fact, even today at investment committee, we’re talking about some of those conclusions. So maybe I’ll share a few.
We talked about a covid aftershock global economy, meaning that covid shock was so significant that the economy would be dealing with some of these issues for many, many years to come. And looking at the world today, I think that still is the case. Inflation is above central bank targets. We’ve made a lot of progress getting inflation back down toward targets, but even over the last few months, in certain parts of the world, including the United States, inflation has remained stubbornly high.
An exciting time for active asset management. You are seeing much less synchronized growth cycles around the world. The United States is an economy growing quite quickly, maybe even overheating a little bit. Inflation is still a challenge. We’re a market where it appears monetary transmission is taking a lot longer to influence the economy and slow it down to a healthier long-term rate. China, not dealing with inflation problem, dealing with the growth challenge, dealing with some disruption and uncertainty across the private sector. And then over in Europe—UK, Europe, even Australia, Canada, a more mixed picture. I think those economies that I just talked about arguably have more sensitivity to front-end policy rates. Mortgage markets, consumer credit markets that are more floating rate, in contrast to the United States, which is a 30-year fixed market, almost in its entirety since the global financial crisis. So more of a mixed growth picture there with a lot more fragility over in Europe.
And when you get to the policy area, a lot of uncertainty there too, but the likelihood for less synchronized policy decisions. Other parts of the world may be able to lower interest rates ahead of the United States, creating more total return potential for those bond markets. The fiscal picture is very different around the globe with the United States having the most significant fiscal response during covid, now running some of the largest deficits in the developed world. Other countries being more fiscally responsible with deficits in the low single digits or even balanced budgets in some cases.
So, in a less global world, a lot of geopolitical uncertainty, a lot of geopolitical tension. We unfortunately think that this is going to be with us for the next several years and leading to a focus on resiliency, bringing supply chains home, less globalization, which probably leads to more symmetric inflationary risks on an ongoing basis. When pre-covid, we were mostly worried about disinflationary risk, central banks are trying to figure out a way to get inflation up toward target.
So, I think it’s a more uncomfortable world, a more uncertain world, but I think there are a couple of positives as well. One, there’s value back at global fixed-income markets. For a while, the US was the only game in town, and it wasn’t much of a game with 10-year Treasury rates, 1%, 1.5%, rates negative in other parts of the world. Now we look and there’s value back in markets where there was none for a very long period of time. Less influence from central banks, so markets are forced to go it alone, move based on the confidence level of the private sector, the good old-fashioned bond vigilantes. That will create some risks that will likely lead to more sustained volatility, but again, great opportunity to take advantage of a global opportunity set.
My sense is, one theme coming out of our secular forum this year will be a lot of near-term uncertainty on inflation, near-term uncertainty on policy, but bonds look pretty good. After a few years of very rough performance while stocks continued to go up across most parts of the world, you have really attractive longer-term valuations. I think that will be a key theme. The second key theme will be, again, a very, very different environment than pre-covid. You truly have a global opportunity set to take advantage of today. Higher-quality areas of the market look attractive and there is still, although a lot of optimism in regards to the US economy, a lot of uncertainty and that uncertainty can be both positive in terms of the potential for significant increases in productivity tied to tech innovation, but any type of tech cycle or innovation cycle can lead to a lot of disruption as well. Unfortunately, with war in key parts of the world and ongoing tension with China in the West, there’s some downside surprises potentially ahead as well. So, again, bumpier than we would like, but opportunity from the standpoint of a fixed-income-oriented investor or an alternatives-focused investor, pretty encouraging, at least relative to where we came from.
Ptak: Considering the recent trends back toward tightening credit spreads and increasing stability in some of the larger economies, including the US, how should an investor think about reconciling that with some of the notes that you sounded in your most recent secular outlook, which talked about an emphasis on resilience and a preparedness for an uncertain, risky future? How should investors tie those two things together?
Ivascyn: Let’s start with fundamentals. The economic data has been quite encouraging, especially in the United States, but generally encouraging in other parts of the world as well. Many forecasters, including Pimco, would have thought you would have needed to see more economic weakness after the significant tightening in policy rates around the globe to address very, very high inflation levels. But we’re here today. Inflation has come down a lot. We’re not quite at the central bank target across most developed markets, including the Australian local market. We’ve made tremendous progress with a decent amount of economic resiliency. That’s the good news.
The bad news is, and as an investor, you, of course, have to look at what’s embedded in market pricing relative to your own fundamental views. So, although the fundamental growth picture and inflation picture has been quite constructive, it’s been accompanied by rallying equity markets and tightening credit spreads around the world.
So, when we look at where we are today, we do think that there’s a little bit of complacency embedded in these very, very high levels of equity prices. We look at the most economically sensitive areas of the credit opportunity set, particularly floating-rate credit that would be senior secured loans, segments of the direct private lending area. Those borrowers are facing the full brunt of central bank policy. Most of them are not perfectly hedged. In some cases, not hedged much at all in regard to interest rates. And there, higher-for-longer scenarios, reaccelerating inflation, the need for central banks to do more could be quite detrimental to overall returns.
So again, I think it’s important to acknowledge that the data has been quite strong. The data has held up, certainly in the US market. But I think a lot of that’s already reflected in current valuations. We still think, given pretty elevated equity markets, pretty tight credit markets, that investors still should look for resiliency. They still should look for areas of the market with a little bit less economic sensitivity, given a lot of optimism in the market, combined with the decent amount of ongoing uncertainty. And the great news is that there are a lot of high-quality segments of the bond market that look really, really attractive.
And I’m sure we’ll talk about this in a bit more detail. But finally, there are alternatives to simply going down in credit quality to try to pick up the income that you’re looking to target as an end investor. And now you can do so in a diversified global opportunity set up in quality. And I think, again, given the uncertainty and given elevated valuations, that’s the focus for now. Over a five-year period, we do think there are going to be opportunities to go on offense, take advantage of portfolio flexibility and liquidity to target some of those riskier segments of the market. Right now, we think, stay up in quality. Don’t try to be a hero. Don’t try to make it more complicated than it needs to be. Focus on the higher-quality areas of the opportunities set. Be active, but don’t max out on risk here.
Ptak: Definitely want to delve into some of those areas that you referenced before that you think are looking more target-rich at this point. Before we did that, I thought maybe we would take a moment to talk about the rate cycle. And the market seems to have misjudged the Fed’s more patient timetable for easing. So, I was curious your views about what that disconnect tells us about investors’ collective expectations versus the Fed’s priority in balancing its mandate to promote full employment, growth, financial and price stability. How does one make sense of that?
Ivascyn: That’s a great question. And there’s a lot there. I think I could probably talk for the rest of the time on just this question alone. It’s a really, really good one. Let me just step back and just say this. I think markets may be a little bit too reliant on policymakers being able to engineer positive economic and financial market outcomes. The covid response was massive, and they prevented a recession or a meaningful recession of occurring. And maybe it would have been healthy given that type of shock to have a period of slower growth to wring out some of the excess in markets. So, I think you go all the way back to the global financial crisis where, yeah, that was quite the shock, but you had a multiyear recovery period with a lot of monetary policy and fiscal help. So, I do think in this environment of higher inflation, higher debt levels across the economy, and Fed and other central banks tightening policy or taking liquidity out of the market, investors need to be a little bit careful in relying too much on policymakers to protect the downside.
Now, with that said, we had a really, really unique trading environment the last few quarters. And it’s always fun when you talk macro and you reflect on times where it’s really, really working well. But it’s been quite amazing the last few quarters where there was so much pessimism in markets late summer of last year. I remember when you hit the local highs in rates in the first week of October last year, a lot of people were focused on the central banks needing to do more. The risks of runaway inflation continuing. The data hadn’t been particularly good. People were concerned about debt sustainability, the downgrade of the US by Fitch. And that turned out to be a great time to enter the market from a tactical perspective. And then you had a few months of really, really good inflation data, which culminated with the Fed press conference where Powell was very, very dovish and signaled to the market a willingness and a likely intention to cut policy rates a lot.
We think that the strong data in the central bank pivot encouraged investors to shift pretty aggressively back into fixed income at an illiquid period of the year. And that likely took valuations at least temporarily down to levels that were reflecting too rosy of a view. We saw six, eight cuts priced into the front of the curve here in the United States and across other global bond markets—cuts starting very, very early this year. And that was tough to reconcile with the still-uncertain fundamentals. And I think the repricing we’ve seen year to date has been about wringing out some of that excessive optimism that was in the market.
The data has been more mixed. But again, you’re talking about in the US, 3%-type inflation rate. We think we probably end up somewhere near that level at the end of the year. And then next year we make further progress. We think in Australia as well, although inflation is remaining sticky to the upside, that you’ll eventually, over the course of the next several quarters in the base case, get to the higher end of their target inflation range of 2% to 3% but with a lot of uncertainty.
So, I think the bottom line is that when we look at the forward curves today, when we look at the forecasts for central bank policy around the world, we’re in the most agreement with forecasters in the forward curve that we’ve been in in a long time. And at these now higher rate levels, we think that the risk/reward proposition looks pretty good today. And in fact, over the course of the last several weeks, we’ve been adding interest-rate exposure because we think that the risk is priced more appropriately. Still a tremendous amount of uncertainty around the central bank policy, but we think the risks are much more symmetrical than we were at the beginning of the year.
Ptak: Investors made a beeline for cash amid 2022′s selloff and the inverted yield curve. Your colleague Aaditya Thakur, who is a portfolio manager in Pimco’s Sydney office, he recently cited some research that Pimco had done examining how bonds perform versus cash at different points in a hiking cycle. So maybe you can talk about what your team found and the implications for markets like Australia where the RBA has been on hold since November of last year?
Ivascyn: So high level, it’s been rough. It’s been rough to be in fixed income versus cash. 2022 was really rough where nearly everything was going down. Equities were going down and normally fixed income helps temper the volatility of a negative equity environment, and it didn’t. It went down as quickly as stocks. So, there’s a lot of fear about extending into longer maturities.
Starting with valuations, though, valuations matter. Fixed income is a less complicated segment of the financial markets than many other areas. The starting yield in a high-quality bond portfolio is usually a very reasonable floor [KG1] as to what you’ll earn over a five-year holding period. So, in Australia, if you have a high-quality portfolio or in the US, any country, you have a high-quality portfolio earning 5%, 6%, 7% over the next five years, you have a very good shot of earning at least 5%, 6%, 7%. So again, that part looks good.
When you look at where we are now in this tightening cycle where the Fed has likely hit the peak in terms of policy and you look at lags from a monetary transmission perspective, this is a time where the historical data would suggest it makes a lot of sense to extend from cash into fixed income. Because typically around now there’s the chance for rate cuts. And given that the forward curves only price in a couple of cuts, we do think that this is a very, very attractive time to shift from cash and to lock in some of those returns. So, yield curves are very, very flat, in some cases inverted, but at these very, very high real and nominal interest rates, we do think it makes a lot of sense.
And the other point from a global opportunity set perspective, there’s a chance that in the US the Fed’s going to have the toughest time cutting policy. The Australian economy, the Canadian economy, some of these other economies around the world have transmission mechanisms that likely impact the consumer sector and even the business sector a bit more quickly and more significantly than the cycle in the United States this time. So, everything we’re saying from a US investor’s perspective will tend to be amplified when you’re talking about other areas of the opportunity set. So even for an Australian investor sitting in Australian cash, thinking about extending, we think it makes a lot of sense. For an investor in the United States sitting in US cash, we think it makes a lot of sense for them to go buy Australia. And you could either do it on an unhedged basis. That looks reasonable to us. But when you hedge back into the US dollar, you have a situation where you pick up very, very attractive yields. You have a country with a very, very strong fiscal position in economy that arguably has a bit more rate sensitivity than the US markets. So even in our US-based portfolios, we think that makes sense.
Ptak: So maybe to play devil’s advocate for a minute for those who would say, there’s still plenty of geopolitical tensions that need to be eased and inflation remains persistently sticky. Maybe it makes more sense to take a wait-and-see more opportunistic approach to extending duration. What would you say to that?
Ivascyn: I won’t disagree too much. What I didn’t say in this conversation so far is that we hit the absolute high in yields. I also didn’t say that there’s no probability of central banks needing to take rates higher. In fact, we think in the United States that may be more likely than some other parts of the world. We think there’s probably a 15% chance or so that rates need to go higher, policy rates, and then perhaps that hold for a while. So, there is a decent amount of uncertainty out there. So, we’re not suggesting that you should try to time the market or take your full cash position and deploy it into the fixed-income market.
It’s more that starting valuations here, even though it may create a lot of anxiety given the price action over the last couple of years, starting valuations support both moving some money from cash into fixed income as well as equities into fixed income as a derisking trade. And we think investors should just acknowledge like we try to do—and I try to tell myself this as well—it’s always hard to time market turning points. When you have a valuation advantage, start allocating back to that sector, average in, realize there is a decent amount of uncertainty, but that uncertainty is symmetric now. There are risks that policy rates have to go higher. There’s also risks that policy rates have to come down a lot faster and more significantly than what’s being priced in. And these things happen very, very quickly. A lot of people didn’t anticipate the significant rally that we saw last year. As an active manager, we were able to extend durations in October, reduce durations toward the end of the year on behalf of investors, now use the selloff year to date to build back a little bit more of that interest-rate risk. So, some of that we’ll try to do on behalf of investors. And again, I think your point is a good one in terms of we’re not through this period of uncertainty. So just head that direction. And again, maybe leave a little bit of flexibility to add on further weakness.
Another point I’ll make too is that higher rates are obviously not going to be great for bonds, but higher rates at this stage may be worse for equity markets and worse for more credit-sensitive areas of the economy like commercial real estate, like lower-rated floating credit. So, cash may prove to continue to be king, but we do think from just a broad asset-allocation perspective, we’re at a point in the cycle where valuations, where the risk/reward proposition for global fixed income is looking better and better and quite attractive again in an absolute sense.
Ptak: I’m going to turn to Australia and the Australian fixed-income market. There’s debate about when the RBA will cut and whether it will coincide with Fed action. Economic growth— and I think you’ve alluded to some of these dynamics—has been sluggish in Australia, the variable rate-borrowing structure, which you referenced as a particular drag there. The RBA didn’t raise rates to the same extent as other central banks did. And inflation hasn’t come down as much. So, what’s your outlook on the path of rate cuts for the RBA?
Ivascyn: We think there’s a good chance the RBA and other global central banks can cut policy a bit later this year. Our economic forecast is for some weakness in the second half of the year and inflation approaching the higher end of the RBA’s target. Similar to the United States, there’s a lot of uncertainty. You could see a situation where the RBA remains on hold for an extended period of time. And there are a few global reflationary type scenarios that could lead to them needing to tighten. But when we look at Australia, we do think you have an economy where the rate-transmission mechanism is more efficient than what we see in the US. We think that you’ll make continued progress on the inflation front. In this cycle, you will potentially be able to see some decoupling in policy. And you may see the RBA, other global central banks, be able to cut ahead of the Fed and to some degree, at least, be able to cut more than the Fed, given that you have a very unique situation here in the US, fixed-rate consumer, credit market, a lot of momentum and innovation around AI and some of this innovative technology. So, there’s natural limits to how much decoupling can occur through the currency channel and a few other channels. But we do think that value is looking pretty darn good in Australia, both absolute and relative.
And then what are we doing about it? Including being quite optimistic about Australian local mandates, we’re adding Australian interest-rate exposure across our broad global diversified strategies. So, we’ve been steadily adding that risk, putting our money where our mouth is, so to speak. And we think from a risk-return perspective, for a very, very sound government from a fiscal perspective, really great risk/reward in the Australian market.
Ptak: The RBA, it does seem a bit less hawkish than before. And I suppose that reflects the puts and takes in the Australian economy, one of the big variables being whether China’s economy will reignite benefiting Australian exporters. Across APAC more broadly, what’s Pimco’s outlook for China? And is there any significant fallout from deterioration from trade relations between China and the rest of the Western world?
Ivascyn: We think China is still a 4% type growth economy, so slower than they would like, slower than we’ve grown accustomed to. But a 4% growth rate on a massive base is still going to be very, very influential to the global economy. China continues to export to the United States and much of the rest of the world, despite significant ongoing geopolitical tension. And they likely do provide the globe with a disinflationary impulse. So, in general, we think that they’re going to continue to have a positive impact on global growth.
Of course, the one almost certainty is that geopolitical tension is going to continue. It’s probably going to get worse, quite frankly. If you look at the political dynamic in the United States, the one area of clear agreement between Republicans and Democrats is the need to take a hard line toward China. We actually think this election cycle will be such that both Trump and Biden, Democrats and Republicans will have to put themselves in a position where they aggressively try to one-up each other in taking a tough stand with China. So, in some sense, box yourself in politically to needing to take a very, very hard stance.
So, I think from an investment perspective, this creates a lot of uncertainty. It’s a little bit harder to invest in China. It creates a bit more uncertainty around the Chinese economy, which can lead to significant economic opportunity for other countries in the region, Australia, Japan, Southeast Asia as well. So, we remain quite constructive on the growth potential, the ongoing development of capital markets in this region, but the China-Western friction is likely to probably get worse and be with us for a long period of time. So, I think you have to think about diversification differently. This is an example of the type of ongoing uncertainty that Australians are going to have to deal with, that we’re going to have to deal with from a global perspective. But I still think it’s important to acknowledge that the Chinese growth rate, even under more pessimistic scenarios over the next few years will still be significant and quite influential.
Ptak: With the BOJ having recently ended its negative rate policy, how far can it afford to push rates into positive territory given its government debt situation? Do you expect to see investors meaningfully repatriating capital from higher-rate countries like Australia back into Japan?
Ivascyn: So, Japan is a very complicated situation. To answer your specific question, I think that they have some limits on how flexible they could be from a policy perspective, rate policy in particular, which is one of the reasons why the currency has been quite weak. It’s been weak just based on simple interest-rate differentials, but it’s been a bit weaker than would have been suggested by just the difference in terms of the yields in Japan versus the yields in the US or other countries. I think the reason the market is reacting that way is that they know that there’s a little bit less flexibility there.
So currently, we’re a little bit underweight the Japanese market. You look at the 10-year part of the Japan curve, you’re still sub-1% in absolute terms, and we have a little bit of an underweight to that market. We have a very mixed view on the currency. Portfolios with a longer-term orientation or a multi-asset portfolio are more willing to have a small positive exposure to the Japanese currency, put more simplistically, a willingness to lose a little bit of money in the base case given that the yen likely performs well in hardly any scenarios for the United States. If you have some US credit exposure, that can be a reasonable compliment. But in a narrow sense, because of less flexibility, we do see the potential for a materially weaker yen.
Then if you continue to have inflationary pressure in Japan, which will exist most likely if you have inflationary pressure on a global basis, the Bank of Japan will likely be slower to raise policy rates, but we do think they’re at a point, and we’ve heard this in the most recent meeting minutes, that they will likely move rates higher in the front end if inflation continues to remain above target and if there’s risks of higher inflationary expectations getting embedded in markets. So, we do think they will move even if it has a negative impact on their risk markets and their economy. But to your point, there’s a little bit less flexibility there creating the potential for tail-type scenarios in Japan.
We can look at the United States as well. We’re still the global reserve currency. We still have a lot of advantages that allow us to run more aggressive fiscal policy than other countries in the world, but even when you look at our own deficit debt picture over the next several years, we’re forecast to be running 6-ish percent deficits for the foreseeable future. And when you look at real or inflation-adjusted interest rates in our economy, they’re beginning to press up against a reasonable long-term growth rate. So, Japan is an extreme example of this dynamic. But even in the United States and some other parts of the world coming out of covid, you have a debt level that may not be a major concern in the US today, but something that bears watching.
And again, what’s Pimco doing about it? We’re keeping our maturities a little bit shorter than we would otherwise. And when we see this type of fiscal situation in the US, we’re looking for other high-quality alternatives to diversify into. Not because we think that there’s going to be a crisis in the US. We don’t even think there’s necessarily going to be a crisis in Japan, although the risks are higher, but we are going to be looking around the world for other high-quality alternatives where there is more policy flexibility. Australia is an example of that. Canada market is an example of that to some degree as well.
Ptak: Turning more broadly to asset allocation, your view, and I think you’ve alluded to it during this conversation, is that high-quality bonds offer superior risk-adjusted returns at this stage when compared with stocks, especially those that are trading at dear multiples, and that yields are generally attractive in fixed income. What are the key implications for investors as they look at bond, stock, and cash allocations?
Ivascyn: Well, again, when you talk about some of these longer-term valuation metrics, just thinking about cyclically adjusted P/E ratios or other longer-term valuation metrics, it’s important to note that they can stay out of whack for a long time. They don’t necessarily have to mean revert very, very quickly. Again, it’s a starting point for an investor, particularly an investor like me that’s been a little bit negatively influenced by all the volatility, especially the ‘22 experience, it’s fine now to look at fixed income not only as a defensive play or a way to improve diversity in a portfolio. It really can be a return generator in absolute and relative terms. You’re at a point now where if history were to repeat itself—and we’ve done a lot of analysis here—that at the current starting point for high-quality global bond yields versus starting equity valuations, there’s a chance that the returns over the next five or 10 years will be very, very similar with less volatility or less uncertainty in fixed income. There’s even a decent part of the distribution where high-quality bonds outperform equities over that same period.
No guarantees. The US market in particular, as we know, has been driven by a lot of large tech stocks. There’s a lot of innovation. There’s a lot of positive scenarios around artificial intelligence and the ability of that sector to drive significant growth. So, when we’re looking to forecast returns over a one- or two-year period, much harder to do. A lot of momentum in the US equity markets, a lot of momentum in global equity markets. So, a decent amount of uncertainty there. But long term, it does look like whatever your neutral point was in terms of allocation between cash, fixed income, and equities, again, taking advantage of a global opportunity set. And again, that’s acknowledging that there’s a lot of short-term uncertainty, but it’s better to have valuation tailwinds than headwinds. If we were having this conversation a few years ago, when yields in the US government bond market were 1%, 1.5% and they were negative 0.5% over in Europe, a very, very different discussion. We’ve come a long way. In some sense, the pain that we’ve all gone through in ‘22 and portions of ‘23 and even this first quarter, that was all a prerequisite to get back to a better valuation setup for fixed income from here.
Ptak: In my last question I wanted to ask you a little bit about alternatives, private credit in particular. If I’m not mistaken, I think that Pimco is bullish longer term on private credit and alternatives, but you’ve also noted some of the risks near term that you see, including losses following a period of rapid expansion and perhaps lacks underwriting standards in pockets of that market. Are you yet seeing any pickup in private loan impairments? And do you have any advice for investors and advisors who are trying to navigate this area?
Ivascyn: Well, maybe I’ll start with a little bit of advice, and I’ll answer your specific question on what we’re seeing from a credit perspective in some of those sectors. I may have prefaced this by saying I’ve been at Pimco now almost 26 years. I grew up being a mortgage, structured product, real estate-type trader. But in reflecting on the last few decades, literally going back 20 years or so back to 2004, I remember people started talking about the golden age of mortgage credit. The idea was US home prices never went down. Therefore, you could aggressively lend to nearly any type of borrower almost regardless of credit quality. So just be a little careful about terms like golden ages of certain types of investing styles. It’s almost never that easy and that type of language in market setup can lead to some complacency and some credit challenges down the road.
I don’t think we’re anywhere close to where we were pre-GFC, but we do have an environment today where policymakers haven’t allowed recessions to occur. Just when they were about to occur for legitimate reasons like a global pandemic, there was a massive fiscal response. With debt levels where they are, with inflation levels where they are, investors can’t count on the same type of response next time. And when you look at all the policy tightening that has occurred and you contrast that to this massive growth in floating-rate lending to lower-quality corporate borrowers, you just want to be a little bit careful there. You want to be selective. You want to make sure that you underwrite managers that are focusing on returns first and growth at their own corporate level second or growing through good risk-return decisions. And we do think that they are the ingredients for a little bit of further excess building up in those markets. So, I think you should just be cautious.
I mentioned the golden age of mortgage lending. Well, that ended poorly. It created a lot of problems. So today, when you look at where you’ve had very solid underwriting fundamentals, limited growth, quality documentation, it’s in the consumer markets today. So ironically, the sectors that created the most problems back 20 or so years ago had the best fundamentals today. The areas that performed reasonably well and were reasonably well behaved from an underwriting perspective back then are the areas where you’ve seen a lot of the growth reduction in investor protections and again, floating rates. So, with a decent mismatch from an asset-liability perspective. So, I think it just warrants caution. Don’t mean to set off the alarmists.
Then to your specific question around deterioration, yes, we have seen very, very strong fundamentals in consumer sectors where you’ve had a very, very strong asset-liability match. US fixed-rate mortgages against a home where there’s been underbuilding for the last 15 years. Really strong performance, only very slight incremental deterioration more recently. In the floating-rate consumer credit markets, but especially the credit markets, you are seeing the pressure from higher interest rates in terms of lower interest coverage levels. On average, when you look in the private markets where there’s less transparency, you even see more extreme deterioration in those metrics. And when you look at the tail, the worst portion of that distribution, there are even greater concerns here.
So, there will be a mindset to extend, to try to buy time. But if you have higher-for-longer rate scenarios, even higher-for-longer rate scenarios that are accompanied by economic weakness or earnings weakness, we do think that there’s going to be more disappointment in those sectors and opportunity for investors to allocate more capital at that point in time. Commercial real estate is somewhere in between. Multifamily is very similar as single-family. Someone can either live in a single-family home or rent in a multifamily unit. There, you have prices that have come down while US single-family homes have gone up in price. The big difference is in the multifamily space, a lot of people funded floating rate and they’re feeling the pressure in the form of higher debt service. So, there’s a lot of good real estate that just has a bad cap structure, just like there are some tough companies that were borrowing in the private floating credit markets now that are facing significant interest coverage stress. So not a catastrophe, but problems ahead, more problems than I think people are admitting at this point in time. So just be a little bit careful there. Don’t make it more complicated than it needs to be. Focus on lending to the consumer, lending to the household, asset-backed lending in areas of the market that have been curtailed or contained based on a lot of the post-global financial crisis regulation.
Ptak: Well, Dan, thanks so much for participating in the Morningstar Investment Conference. We so appreciate your time and insights and for giving us the perspectives that you have. So, thanks again.
Ivascyn: Thanks. Appreciate it. As always, it’s great to spend some time with you and best of luck for the rest of the year. Thank you very much.
Ptak: Thank you. From Newport Beach, I’m Jeff Ptak signing off.
(Disclaimer: This recording is for informational purposes only and should not be considered investment advice. Opinions expressed are as of the date of recording. Such opinions are subject to change. The views and opinions of guests on this program are not necessarily those of Morningstar, Inc. and its affiliates. While this guest may license or offer products and services of Morningstar and its affiliates, unless otherwise stated, he/she is not affiliated with Morningstar and its affiliates. Morningstar does not guarantee the accuracy, or the completeness of the data presented herein. Morningstar shall not be responsible for any trading decisions, damages or other losses resulting from or related to the information, data analysis, or opinions, or their use. Past performance is not a guarantee of future results. All investments are subject to investment risk, including possible loss of principal. Individuals should seriously consider if an investment is suitable for them by referencing their own financial position, investment objectives and risk profile before making any investment decision.)
[KG1]Fore? Time: 16:15