Bond giant PIMCO has officially begun its new era without former CEO Mohamed El Erian by saying that the global economy will be stuck in a ‘New Neutral’ for the next few years.
In its latest Secular Outlook, a report from the California-based group’s annual gathering of its investment team to establish its market view for the next three to five years, the US group said its ‘New Normal’ view which described the period of below-average economic growth after the financial crisis has morphed into the ‘New Neutral’ which plans for sluggish growth.
‘The global economy has not as of today found a growth model that can generate and distribute global aggregate demand sufficient to absorb bountiful global aggregate supply,’ the firm’s global strategic advisor Richard Clarida wrote to explain the concept.
‘Unless and until it does, we will be operating in a multi-speed world with countries converging to historically modest trend rates of potential growth with low inflation. 0% neutral real policy rates for many developed and some developing countries will likely be the investment outcome.'
Company founder Bill Gross, who manages the PIMCO Total Return fund – which has suffered record outflows over the last year bringing it from a high of $289 billion at the end of March 2013 to $230 billion at the end of April 2014 – said many investors in the market place were wrong to expect more tightening from the central banks.
‘While we would admit that PIMCO, policymakers and investment managers worldwide are uncertain as to what neutral policy rates in the US and other economies should be, we are confident that asset markets have gone too far in believing that central banks can even approach policy rates that seemed “neutral” for decades prior to Lehman in 2008,’ said Gross.
'PIMCO internal research as well as historical statistics over the past century suggest “neutral” is much closer to 0% real (especially during periods of high leverage and low growth) than the 1-2% currently anticipated by asset markets.'
What does this mean for investors?
He went on to explain what the investment implications of these neutral policy rates would be.
‘Low returns yet less downside risk than investors currently expect; an end to bull markets as we’ve known them, but no perceptible growling from the bears, ‘said Gross.
‘The reason is that New Neutral global policy rates lower than currently priced into asset markets allow for a margin of safety that reduces downside risk and minimise bubbles.
‘The New Neutral is not an explicit Yellen or Draghi Put but it can be a rather comforting pacifier, suggesting that yields, credit spreads and P/E ratios themselves are more rational than many market observers fear.’
Gross admitted that at first glance there appears to be more risk than reward on the horizon.
'However, if the New Neutral plays out, the bubble risk may be lower than expected, while asset returns are likely to be subdued, in the 3-5% range.'