‘Unknown unknowns’ could distort the probability curve for 2017 well beyond the norm, according to the latest cyclical outlook from global bond mega-manager PIMCO.
The PIMCO analysis says events of the previous 12 months have put the world on notice for further surprises with the “only certainty” for 2017 “that the tails of the distribution of potential macro outcomes have become fatter”.
“Fatter tails and a lower probability of the baseline scenario unfolding imply that, more than ever, we have to think about the outlook in terms of different scenarios and be open to scenario switching depending on the actual policies that get implemented,” the report says.
The paper, authored by Joachim Fels and Andrew Balls (PIMCO global economic adviser and chief investment officer global fixed income, respectively), says investors should consider overweight tail risk on both sides of the curve.
“Left-tail risks are defined by rising debt, monetary policy exhaustion and the populism-powered transition from globalization to de-globalization,” PIMCO says. “Right-tail opportunities may emerge from potential deregulation, awakening animal spirits and the accelerating transition from exhausted monetary to growth-supportive fiscal policies.”
Overall, the world’s biggest fixed income manager says it plans a “cautious” approach to portfolio construction over 2017 with an eye on the fat tails and capital preservation. PIMCO will also be “de-emphasizing” trades based on central bank support while watching out for the “asymmetric risk of rising yields and especially against negative yields”, the outlook says.
However, the manager will also be on the lookout for opportunistic plays “to take advantage of periods of volatility and market dislocation”.
“The experience of the past year has highlighted political risk and central bank policy exhaustion. At a time of fair to expensive valuations and less liquid financial markets, we have seen that it does not take much to prompt bouts of market volatility,” the PIMCO article says. “By keeping portfolios lighter on risk and by being tactical and flexible as active managers, we can prepare for and look to benefit from market turning points. We think that patience will be rewarded.”
PIMCO forecasts global real GDP growth for the year ahead of between 2.5-3 per cent ranging from a worst-case scenario of 0.25 per cent in Brazil to a bullish 8 per cent in India. The US could expect growth of between 2-2.5 per cent in 2017, the report says.
Meanwhile, the analysis says global inflation could range from 2-2.5 per cent next year compared to an expected 1.6 per cent in 2016 with Japan (0.25 per cent) at the bottom end and both Brazil and India (the lowest- and highest-growth countries respectively) topping out at 6 per cent.