Pacific Investment Management Co. — an arm of Allianz — has a new secular outlook. Suffice it to say, the fixed-income behemoth isn’t looking at the debt markets through rose-colored glasses.
“We have probably the riskiest credit market that we have ever had,” said Scott Mather, chief investment officer of U.S. core strategies at Pimco. It’s like before the financial crisis, he said. “We see it in the buildup in corporate leverage, the decline in credit quality, and declining underwriting standards — all this late-cycle credit behavior we began to see in 2005 and 2006.”
Meanwhile, ever-popular collateralized loan obligations will bear the brunt of losses in leveraged loans when the business cycle turns, according to portfolio manager Beth MacLean. And to top it off, the U.S.-China trade war is poised to cut into already decelerating global growth, noted Tiffany Wilding, Pimco’s U.S. economist. A recession in advanced economies might be in the cards in the next three to five years, the period covered in the firm’s outlook.
Basically, as Pimco Global Economic Adviser Joachim Fels put it to Bloomberg Televison’s Jonathan Ferro: “We’re seeing the end of an era. … We’re now entering an age of disruption.”
What Goes Up…
Frankly, those concerns aren’t exactly novel. The fact that a growing share of the U.S. investment-grade corporate bond market is rated triple-B is so well-known by now that I’ve argued it’s unlikely to be the flashpoint for a crisis specifically because the risks are so well telegraphed. As for CLOs, well, they own two-thirds of the leveraged-loan market, so it’s only natural they’d be the ones suffering a big hit when weak covenants come back to haunt investors — again, a much-publicized issue. And MacLean specifically highlighted the equity portion of the structures as taking much of the potentially $150 billion in losses, which is exactly what they’re supposed to do to shield highly rated tranches.
Rather than those warnings, what caught my attention from Pimco was an idea that should be somewhat scary to all investors — that central banks are no longer all-powerful and don’t have the capacity to help support markets. Here are some select quotes from Mather:
“Markets have become used to an environment where central banks are really powerful in terms of taking volatility out of the market and pumping asset prices up. That era is coming to an end.”
“The U.S. is about the only central bank that was able to normalize policy rates, but elsewhere, there’s basically no monetary firepower left.”
“People are starting to come to a more realistic outlook about both the forward-looking growth prospects, as well as the power of central banks to pump up asset prices.”