Investors can increasingly find more value in markets, despite the uncertain outlook, if they are optimistic about the ability of central banks to manage inflation over the next two to three years.
This is Pimco’s view, with the US fund house becoming more constructive about interest rate levels more broadly.
“This volatility, although it feels terrible living through it, is creating potential opportunities across sectors that could generate an attractive yield without going down the credit spectrum too significantly,” said Daniel J Ivascyn, group chief investment officer at Pimco.
Taking a high-quality investment grade bond as an example, it if returns 4%, 5% or even 6% today, that instrument would offer good value relative to recent markets if there is a return to inflation of 2.5% to 3%.
“There is a degree of optimism that we haven’t witnessed in quite a long time,” Ivascyn added.
Caution in credit markets
For the time being, the rising risk of recession should breed caution among investors about credit-sensitive investments.
“The big challenge is that we have an inflation problem, so you have policymakers tightening when growth is already relatively low. And it’s been a long time since there has been a recession without massive policy support,” explained Ivascyn.
For example, the wave of capital that has flowed into credit-related assets over the past decade in search of incremental returns has spurred significant growth in some of the lower-rated or private segments of the corporate credit market. There has been deterioration of fundamentals in certain areas.
“Those areas warrant caution, especially those within the private space that haven’t repriced yet,” added Ivascyn.
By contrast, he sees resiliency and attractive spread levels in household credit, asset-backed credit, mortgage credit, banking credit and financial sector credit.
Public and private pockets of potential
In the public space, Pimco sees a lender’s market, based on its view that many deals within the corporate and financial sectors will be resilient during more volatile economic times.
As a result, the higher-quality areas of the investment-grade universe might generate extra yield. “High-quality bank paper is one example. You could see one-and-a-half, even two, percentage points above a Treasury yield,” added Ivascyn.
Meanwhile, there has been some widening in lower-rated, more credit-sensitive areas of the markets.
“One of the most exciting areas… that we see over the next several years would be contingent capital vehicles to take advantage of the dislocation that’s almost certain to exist within the large stock of existing corporate credit assets,” said Ivascyn.
Emerging market value
Pimco also believes emerging markets look interesting from a valuation perspective, assuming investors can navigate what the asset manager describes as “a tremendous amount of idiosyncratic uncertainty”.
Such opportunities that stem from this situation require a selective approach in terms of the country, instrument and sector.
“Be careful, but don’t avoid the asset class, because we think it will be quite target-rich,” said Ivascyn.