We listen to our clients’ input on a wide range of topics – including about our investment commentaries. Some clients have suggested I add a little more color, as when I wrote about my own experiences with the housing market in “For Sale” (2006) and “Back In” (2012). With that in mind…

Staying fit

One of our senior managing directors used to joke that he knew he had influence around here when he was able to have a clock installed in our large conference center in our previous office in Newport Beach. Well, just under a year ago, a few of the firm’s “fitness nuts” were consulted about what time the gym should open in our current building. So, it’s 2 a.m. (And, yes, we do use it that early!)

In fact, we have been focusing on health throughout PIMCO. In addition to the gym, our employee cafeteria now offers more healthy options and, on a personal level, I am working with a nutritionist to customize a diet that promotes maximum energy. I needed to “step up” – I sit next to a fourth- degree black belt and two-time World Cup winner in Karate and am surrounded by several serious athletes and former decathletes. This is PIMCO!

How does health relate to investing? Investing is a marathon, not a sprint. I strongly believe that, as dedicated and focused global investors, we need to stay fit and focused to capitalize on the significant investment opportunities available today.

Early birds get the worm

We also set our alarm clocks early to attend video calls and meetings with our colleagues in North and South America, Asia and Europe to make sure we are capturing all the significant top-down and bottom-up investment opportunities around the world. Here are some of the topics and questions we discuss:

  • What are the best investment opportunities in North and South America – particularly in the U.S., given that the Federal Reserve will likely be tightening monetary policy this year?
  • Where are the opportunities in Europe given that the European Central Bank’s (ECB) significant quantitative easing (QE) program has begun?
  • Are there opportunities in China given the government’s need to rebalance the economy’s growth model and the anti-corruption measures that have slowed growth?
  • What are we expecting in terms of future monetary policy in China, and will potential easing from the People’s Bank of China (PBOC) lead to investment opportunities?
  • How should investors position themselves to benefit from the Bank of Japan’s (BOJ) aggressive QE program?

Focusing on the big picture

We attempt to answer these questions by summarizing the main top-down macro themes that are driving financial markets. Today, as well as over the past several years, many powerful forces are driving markets and asset prices, but global monetary policy, technicals and fundamentals stand out.

Global monetary policy

Central banks are increasingly going “all-in” to help offset global deflationary pressures, the absence of fiscal policy in most developed markets and weak overall aggregate demand growth. In many developed economies, central banks have been aggressively expanding balance sheets, ramping up QE programs and moving short-term interest rates lower in a “race to zero” (see Figure 1). These policy actions have led to aggressive foreign exchange movements.

Figure 1 is a line graph showing the balance sheets as a percentage of gross domestic product for four major central banks from 2007 to 2014. By 2014, Bank of Japan’s balance sheet represents 60% of its GDP, up from 25% in 2012, and far more than the other three banks featured. In 2014, the Fed’s balance sheet is around 25% of GDP, up from roughly 7% in 2007. The Bank of England’s is around 25%, up from 12% in 2007, and the ECB’s is around 16%, up from 10%.

Other consequences: Investors all over the world are taking more risk by extending durations, buying longer-maturity bonds they suspect central banks may be buying in the future, and moving into what we call at PIMCO the “outer- perimeter” risk assets, including corporate bonds, high yield bonds, equities and real estate (see Figure 2). Guess what? This investment strategy has been working for years! And, it shouldn’t be surprising because global central banks collectively have reduced left-tail risks by pushing out the next recession and helping to prolong the economic expansion. Investors who have recognized this trend have been rewarded as global central banks, combined with a gradually improving private sector, are pushing up most asset prices. Lower long-term interest rates are also boosting real estate as well as equity prices.

 The figure shows nine concentric circles, surrounding a core labeled “Fed funds overnight (O/N) repo.” For each circle, risk increases, going from 3-month Treasuries, commercial paper and two-year T-notes, all the way out to outer perimeter risk assets, such as corporate bonds, high yield bonds, equities, and real estate.


Market technicals are essentially the supply and demand of bonds. Simply put, there is more demand for high-quality income-producing assets than there is supply of those assets. Why? Savings exceeds investment globally. We continue to have a global savings glut and a lack of “animal spirits” for new investment. While the world continues to lack global aggregate demand, central banks are pushing excess savings into outer-perimeter assets by lowering the return on cash and, in fact, now causing safer, shorter-maturity debt and government bond yields to go negative across many areas of Europe and in Japan.

Meanwhile, investors have taken note and many are moving into other areas. Given government-bond market technicals, where some central banks are on track to buy more than the net issuance in some markets, investors are likely to continue to move more assets into stocks and corporate bonds. These global investment flows should support the prices for equities and higher-yielding corporate bonds, particularly in companies that pass our five fundamental screens:

  • Strong barriers to entry (see Figure 3)
  • Solid cyclical or secular growth
  • Pricing power
  • Superior assets
  • Healthy balance sheets and liquidity

Figure 3 is a diagram showing barriers to entry in credit markets, arranged as two arrays of boxes, each representing a barrier. The two arrays are separated by a two-way arrow in between. On the left-hand side array, the barriers include patent, license, brand, content, intellectual property, permit, real estate/land, and contracts. In the array on the right-hand side, barriers include regulated industry, high switching cost, high capital intensity, low cost structure, superior product quality, and innovation.

Top down/bottom up

How healthy are countries and companies around the world? It turns out, public and private sector fundamentals vary dramatically. This is why we are constantly focused on coordinating across our global team of 260 portfolio managers and 61 analysts around the world.

Given the continued presence of deflationary forces in some regions, we are increasingly determined to play good defense through discipline in our bottom-up and top-down investment reviews. Risks are increasing over both the cyclical and secular horizons, including the potential for a hawkish surprise with Fed tightening as well as a substantial slowdown in growth in China. In addition, energy and commodity price volatility could have significant consequences for a select group of countries and companies. Finally, many companies today lack strong barriers to entry, solid cyclical or secular growth, pricing power or superior assets.

Fortunately, our active management of these risks could add to our overall alpha generation as we attempt to avoid these companies while focusing our attention on the areas of the world and specific investment opportunities that not only pass our fundamental investment screens, but also offer attractive risk/reward trade-offs (e.g., have favorable downside risk protection).

Global investment opportunities

Given these big-picture themes, where are we finding the most attractive investment opportunities today? Some of the largest factors driving asset prices – global central banks, technicals and fundamentals – remain supportive for credit and equity markets across many regions, and especially so for select companies in the U.S., Europe, China and Japan across many sectors.


The Federal Reserve is likely to begin the first step in removing policy accommodation this summer by raising the fed funds rate off zero. We expect the pace of rate hikes will be gradual due to headwinds from the global economy and a strong dollar. The Fed wants to see more wage inflation as well as continued strong job creation. With support from aggressive monetary policy, the private sector – including consumers, companies and banks – continues to heal and improve.

We therefore continue to favor cyclical consumer sectors in the U.S., including gaming, lodging, airlines, theme parks and autos. We also believe household formation will pick up given solid job growth. As such, housing and housing-related industries, including homebuilders, home improvement, title insurance and building materials, should remain supported. Financials and banks should also continue to benefit from an improving overall economy and private sector. Finally, low oil and gas prices are leading to some attractive bottom-up opportunities in select pipeline, midstream and exploration and production (E&P) companies in North America.


The ECB has embarked on a significant QE program to help stimulate growth and fight off deflation in the eurozone. For those who doubted “Super Mario” almost three years ago when he made his promise to do “whatever it takes,” there should be no doubters now. The ECB is on a mission. In fact, Draghi has been very specific that the ECB will engage in open-ended QE until Europe is on track to deliver inflation near 2%. With the Fed set to raise interest rates this year, the ECB’s ongoing policy support will likely lead to a weaker euro as well as gradually higher European inflation, albeit from very low levels, over time.

For investors, the message is clear to own outer-perimeter risk assets in Europe. We have been favoring European equities, bank capital securities, high-yield bonds and corporate hybrids. These assets should benefit from the ECB’s highly accommodative monetary policy as well as Europe’s improved growth outlook due to the weaker currency and lower oil prices. Should green shoots sprout in Europe, which we expect across some regions, investors will want to own outer-perimeter assets that pass our bottom-up investment screens. Exporters that benefit from a weaker euro, as well as European telecom/cable and building materials companies that may slowly regain pricing power, are a few other areas we find interesting today.


The Chinese economy is undergoing a significant political and economic structural change that is causing growth to slow. Politically, China’s anti-corruption campaign has been more far-reaching than most would have anticipated. It is also having a significant economic impact by weakening “animal spirits” for high-end consumption and business investment. This is also happening at a time when the Chinese property market remains under pressure and the government is attempting to rebalance the economy away from public sector investment and toward consumer spending.

So should investors stay away from China? No! That would be backward thinking – despite short-term headwinds, the government’s anti-corruption campaign should improve governance and efficiency in the vast government and public sector.

In fact, several investment opportunities, both near-term and medium-term, have surfaced in the Chinese property sector and technology/internet areas as well as in Macau gaming. What is the catalyst? Near term, China has already begun loosening monetary policy. We should see more aggressive rate cuts by the PBOC this year as well as further liquidity injections into markets. These policy actions together with potential fiscal policy stimulus should support risk appetite and the property sector over the cyclical horizon. Over the medium term, China’s explosive growth in mobile and Internet users and online shopping continues to support a select group of companies focused on the Chinese consumer while continuous infrastructure improvements and growth in the middle class should increase visitation to Macau.


Like the U.S., Europe and China, Japan is benefiting from lower energy prices. Japanese consumers are also being supported by low unemployment, the prospect for gradually higher wages, rising property prices and Prime Minister Abe’s decision to delay the second value-added tax (VAT) hike. A weaker currency is helping Japanese exporters and corporate profits, and pro-business policies such as planned corporate tax cuts and corporate governance reform will also likely support the Japanese corporate sector.

In addition, the BOJ’s aggressive QE program has been, in one word, bold. In fact, as a percent of nominal gross domestic product (GDP), the BOJ’s balance sheet is the largest of the major developed market central banks. Similar to the ECB, the BOJ is targeting 2% inflation and the central bank will engage in open-ended QE until this target is achieved.

We see several investment opportunities in Japan. We would highlight cyclicals and exporters, which should experience tailwinds from a weaker currency, and banks and financials that benefit from an aggressive QE program as well as a gradually improving private sector.

Mark Kiesel
Chief Investment Officer Global Credit
March 22, 2015

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Mark R. Kiesel

CIO Global Credit

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