Fixed Income

Pimco’s Dan Ivascyn on inflation risk and market volatility

Fixed-income expert on whether this is the beginning of a secular bear market in bonds.

Pimco has been riding a wave of success, reporting a fourth-quarter operating profit of $684 million, the highest since co-founder Bill Gross left the firm in 2014.

Many have attributed the company’s revival to chief investment officer Daniel Ivascyn, who manages or co-manages many of Pimco‘s fixed income strategies, including the $112 billion Pimco Income Fund (PONAX).

InvestmentNews spoke with Mr. Ivascyn about his reactions to the markets at the 2018 Health and Wealth Leadership Forum in Boston on Thursday, and asked him about the challenges and opportunities he sees in bonds.

Ryan W. Neal: What are you thinking about the stock markets since the first quarter of 2018?

Dan Ivascyn: We think we are later cycle. In general, valuations are stretched full.

This is the time to be more cautious. We don’t want to sound overly alarmist. We don’t see the types of imbalances that we saw in the 2006-2007 period, but there are still record levels of debt around the world.

RN: We just had our Retirement Income Summit in Chicago, and the general sense we got from the speakers was that a bear market is not necessarily coming, but prepare for lower returns and higher volatility. Would you agree?

DI: That’s a real good way of putting things. And then in the fixed income markets in particular — and this is where our views at PIMCO may differ from some — is that we think there is some risk of inflation rising above central bank targets over the short term. We don’t see sustainable inflation concerns over the intermediate or longer term. We think what we’re seeing is somewhat typical late-cycle behavior. You have very low unemployment rates, you’re seeing some signs of labor shortages, you’re seeing an uptick in wage pressure, an uptick in inflation pressure, but this is what tends to happen at the end of an expansion. The central banks will be able to address this. We don’t think this is the beginning of a secular bear market for bonds.

We still think fixed income has a place in a diversified portfolio. We are cautious on interest rates over the short term. Rates could certainly go higher into year end, but we would view that as a buying opportunity most likely, not something to fear from the standpoint of sustainable increases in rates.

RN: Outside of interest rates, what else is impacting fixed income?

DI: One area that has been important of late are just tracking global financial flows. These markets are more interconnected than ever before. You have a situation where key part of the world like Europe and Japan are still in negative interest rate territory and their investors are desperately looking for alternatives to obtain a positive yield. But they don’t necessarily want to take currency exposure. This gets more technical, but the bottom line is, shifts in relative valuations around the globe, at least partially due to all this central bank activity, are creating a lot of technical flows.

In addition to those factors, we think we’re at a point in the cycle where politics matters a lot. Obviously the Trump administration has a very unique style, both in terms of how they push policy forward but also from a communication perspective. There’s lots of uncertainty, or increased uncertainty around trade. That’s an area that we’re spending a lot of time focusing on.

(More: Pimco views 3% 10-year yield as buying opportunity)

RN: What impact could this have on fixed income?

DI: In terms of the global trade environment, this could have a direct impact on the price of various goods within industries. You’ve seen it with steel, winners being domestic steel producers, losers being offshore producers. If you have corporate credit exposure to those entities, it’s something to think about. Other geopolitical tensions like the sanctions on Russia recently created tremendous volatility both across the Russian complex — government bonds and currencies — but also names that were specifically sanctioned were impacted.

RN: What has you most excited out there?

DI: A few things. One, there’s finally some yield in the front end again. I think clients are beginning to appreciate that — even managers at PIMCO are. It’s been almost a decade since you could actually invest in short-term assets, money market funds and generate yield. So today, for example, you can buy two-year, three-year maturity, high-quality bonds and generate yields of 3, 3.5%. Not earth shattering, particularly if you’re covering the tech sector or tech stocks, but if inflation stays at about 2% and you can generate a percent and a half above inflation, that’s pretty good.

We’re excited about the fact that growth is pretty good globally. Still a lot of risks, still a lot of debt, we probably would like to see a bit more structural reform at the government level to address some of these frictions that are keeping potential growth rates lower than they probably should be. But the global economy is not that bad.

We tend to like the financial sector within the corporate bond market because of the fact they have more capital and their level of risk taking has been reduced. We like the housing-related sectors. We’re a bit more cautious on the more generic forms of corporate credit risk.

Finally, emerging markets. There are some things we like there. We think it’s a reasonable source of diversification, but the emerging markets are going to be very, very volatile.

RN: Any closing thoughts for us?

DI: At this stage of the cycle, you just require more precision. The easy money has been made. We’ve been in the midst of a multi-year, post-crisis recovery, and I just think these markets are more global, they’re more complicated. To achieve success on behalf of clients, it’s the details that are going to matter.

You want to be more creative, you want to be global, you want to be out there in these new frontiers searching for value, because it is becoming more difficult.