Move over, “new normal.” The “new neutral” is here.
Bill Gross’s Pacific Investment Management Co., which under former Chief Executive Officer Mohamed El-Erian popularized the term “new normal” to describe an era of below-average economic growth following the financial crisis, says growth won’t gather much more traction in the coming years.
The global economy will be stuck in a “new neutral” for the next three to five years, characterized by a convergence of the largest economies to slower yet more stable growth rates, Newport Beach, California-based Pimco said in a report today outlining the conclusions from its annual Secular Forum held last week. With little risk of runaway inflation, interest rates will remain below pre-crisis levels, Pimco said.
“We think of the ‘new neutral’ as a natural evolution from the ‘new normal’,” Executive Vice President Richard Clarida, who oversaw the annual forum at the Newport Beach, California- based firm for the first time this year, said in a telephone interview. “The ‘new neutral’ looking forward is a story about a global economy that isn’t recovering, it’s a global economy that’s converging to trend rates of growth that will be sluggish.”
Pimco’s outlook marks the beginning of a new era at the firm, which in January announced the abrupt resignation of El- Erian, and comes after a year of unprecedented upheaval at the $2 trillion money manager. Pimco is struggling to reverse record redemptions from Gross’s $230 billion Total Return Fund, which has trailed peers in the past year. The firm also completed its biggest management shakeup ever after El-Erian’s departure, which was followed by reports of clashes between him and Gross.
Gross, 70, who started the firm in 1971 with two other co- founders and has built one of the best long-term records in the industry, fell behind 87 percent of rival funds over the past year in the Total Return Fund. Over the past five years, the fund is beating 58 percent of peers, according to data compiled by Bloomberg.
The Secular Forum guides Pimco’s world view and investment philosophy, providing “guardrails” for how it will deploy money over the next three to five years.
In the aftermath of the 2008 financial crisis, Pimco used the term “new normal” to describe an era of subdued returns, heightened government intervention and increasing clout for emerging nations in the global economy. Prior to that, the term was used in a May 2008 Bloomberg News article. The phrase “new neutral” was used in a Bloomberg News article in March to highlight benchmark interest rates below historic averages.
Pimco has revised its forecast to highlight faster economic growth in the U.S. than it previously thought, a slower pace of expansion in emerging markets such as China and fewer policy options to stimulate global growth.
While the latest thesis shares a similar view of subpar returns as the “new normal,” the outlook is more stable compared with what Pimco forecast five years ago. That’s because central banks recognize that to keep the global economy functioning, “policy will have to tread carefully,” Clarida said.
“You proceed very, very cautiously to normalized rates.”
Generating returns is becoming increasingly difficult as central bank policies elevated prices on so-called risk assets, according to Pimco’s report. At the same time, risks to the markets are lower under Pimco’s new scenario.
“There may be lemonade to be made from those low returning lemons,” implying about 3 percent returns for bonds and 5 percent for stocks, according to the report.
Research that digs up individual “secular winners” will now drive returns, meaning increasingly popular strategies such as exchange-traded funds that pick securities to mirror the returns of a benchmark index won’t serve investors well, Clarida said.
Pimco expects growth in China to ease to 6 percent to 6.5 percent, from 7.5 percent that the nation’s leaders are aiming for, according to the report. In Europe, the average annual growth will probably not exceed 1.25 percent, Pimco said. In the U.S., Pimco expects as much as 3 percent growth this year.
“Of the world major economies, the U.S. is the one you can make an optimistic case,” for growth, Clarida said.
Pimco’s outlook for the U.S. is in line with other investors, with almost two-thirds of investors in a Bloomberg Markets Global Investor Poll describing the largest economy as improving.
Still, the U.S. Federal Reserve won’t be able to raise rates as much as it projects, with a real policy rate of probably closer to zero, combined with inflation of about 2 percent, Clarida said.
Fed Chair Janet Yellen is due to speak May 15 after using comments last week to temper speculation an improving U.S. economy will accelerate an increase in interest rates. Yellen said in two days of testimony to U.S. lawmakers the economy still requires a strong dose of stimulus five years after the recession ended because unemployment and inflation are short of the Fed’s goals.
Scott Mather, head of global fund management and one of Pimco’s six deputy chief investment officers, said in a Bloomberg Surveillance interview with Tom Keene and Michael McKee last month that the firm was moving away from the new normal, and the economy was “going to head back to a new destination.”
Mather is one of a new generation of top executives at Pimco after it revisited its leadership plans. Gross named Mather a deputy CIO in January, along with Andrew Balls, Dan Ivascyn, Mark Kiesel, Virginie Maisonneuve, and Mihir Worah.
“Scott was a little out over his skis in terms of declaring the new normal dead,” Gross said in a radio interview May 2, saying that would be debated in the upcoming forum where strategists and investment professionals listen to external speakers including Harvard University professor Carmen Reinhart and FiveThirtyEight.com founder Nate Silver, and debate and solidify the firm’s forecast.
El-Erian, 55, who writes a daily column for Bloomberg View, the opinion section of Bloomberg News, serves as chief economic adviser to Pimco’s parent company Allianz SE. El-Erian last month said the markets are in a state of “secular stagnation.” In a Bloomberg View column yesterday, he wrote that financial markets will become more volatile in the weeks and months ahead.
“The hope for markets is that the global economy will mitigate high valuations and various destabilizing forces by gaining momentum and reaching escape velocity,” he wrote. “Unfortunately, there is as-yet insufficient data to suggest that this will happen any time soon.”
Pimco’s 'New Normal' Thesis Morphs Into 'New Neutral'
May 13, 2014
Move over, “new normal.” The “new neutral” is here.