- As the global economy goes through significant change and a new administration takes charge in Washington, the potential for both left-tail (downside) and right-tail (upside) market outcomes has increased
- The main left-tail scenario involves the risks of trade restrictions and protectionism, anti-immigration policies, dollar strength and an escalation of geopolitical conflicts
- The right-tail scenario centers on upside potential from faster global growth driven by higher government spending, lower taxes and deregulation
- With equity and credit markets pricing in mostly right-tail outcomes, PIMCO has been de-risking portfolios broadly across the credit markets
Compared with about a year ago, when PIMCO increased credit risk, they are taking less overall credit and “spread risk“, and have been shifting their portfolios into areas of the credit market where they see the most favorable risk/reward. This shift, while subtle, underscores their views on credit sectors positioned to withstand the potential changes and uncertainties in the market outlook. Specifically, PIMCO sees opportunities in the following areas in global fixed income credit sectors:
High quality corporate bonds: PIMCO favors industries tied to the U.S. consumer, including cable, telecom, gaming, airlines and lodging, which should remain supported by solid consumer fundamentals, rising confidence and prospective tax cuts. They also continue to like banks and financials, which benefit both from moderately higher interest rates and steeper yield curves as well as the potential for less onerous and costly regulation under Trump. Finally, PIMCO continues to believe mid-stream energy/MLPs/pipelines offer the most attractive risk/reward in the energy sector given higher energy prices and the prospect for a pickup in volume growth in the U.S. shale regions.
Bank capital/specialty finance: They believe select opportunities exist in U.S./UK/European bank capital securities and specialty finance companies where their bottom-up credit research seeks to identify companies with improving fundamentals. “These sectors should benefit from a gradual pickup in nominal GDP, an improvement in earnings growth and rising equity market capitalization. Current bank capital valuations have cheapened relative to high yield, and deregulation should be particularly supportive for specialty finance companies”.
Non-agency mortgages: The risk/reward on non-agency mortgages continues to look attractive given current loss-adjusted spreads and a healthy U.S. housing market, which remains supported by a solid labor market, deleveraged consumer balance sheets and favorable demand/supply.
Agency mortgages: Valuations on high-quality agency mortgages have cheapened considerably over the past few months. They are now increasingly attractive both outright as well as relative to U.S. Treasuries given the recent backup in interest rates.