Geopolitical uncertainty, a greater likelihood of a U.S. recession and stubborn inflation may make investors shy away from riskier investments.
Whether its Russia’s war in Ukraine, Asia grappling with the end of Covid restrictions, stubbornly high inflation or the current debt ceiling negotiations in the U.S., it is all adding to the uncertainty that’s been the backdrop for the markets for the past few years.
Speaking at the Morningstar Investment Conference in Chicago this week, Dan Ivascyn, chief investment officer for bond giant Pimco, said his firm believes there’s a low probability that the U.S. will default on its debt obligations while Democrats and Republicans negotiate raising the debt ceiling. But the fact that there’s even a discussion about a fiscal cliff shows “there's incredible dysfunction in D.C.,” he said.
“That's not great going into a period of economic weakness.”
Lingering worries about regional banks add to the larger uncertainty. This is affecting general economic sentiment and could have an overhang on markets.
“The longer it takes for [the debt ceiling] to be resolved … the less likely households or businesses are going to take the type of risk that they were taking prior to those episodes,” he said.
He also expects more market volatility as the debt ceiling debate continues and recession concerns grow, problems that may keep investors parked in more liquid assets.
“Anytime you have more volatility, it's great to be more liquid, both from the standpoint of pure cash, as well as just being more liquid in terms of the overall continuum of assets that you hold,” Ivascyn said.
There are parts of the market Pimco likes, such as private credit, non-traded real-estate investment trusts and agency mortgage-backed securities. He also said yields remain “quite attractive” in the higher quality segments of the market, something that he expects to continue.
Despite his interest in certain investment types, he urged investors to keep a longer-term view and try to withstand short-term market gyrations in the highly uncertain economic environment.
He pointed to the ways agency mortgage-backed securities, corporate debt and other high-quality debt investments were temporarily hit during the Covid-19 pandemic before rebounding. “We don't know for sure how they will trade, and therefore you have to have a healthy respect for the mark-to-market risk,” he said.
More recently, he pointed to the sudden turmoil in the U.K. markets when Liz Truss, the short-lived prime minister, unveiled an aggressive economic plan that was eventually pulled.
“We live in a highly uncertain world where this could happen very, very quickly. It happened in the gilt market in the U.K., where you had a policy that … perhaps was insufficiently thought out. In one of the highest quality mature markets in the world, you had this massive seizing up in their government market,” he said. “In general, you always need to make sure that you have the wherewithal to withstand unanticipated market volatility.”
He added that inflation has disrupted the normal behavior, including correlations, of stocks and bonds. He pointed to market activity this week in which fixed-income markets rallied after weak earnings from First Republic Bank.
“Until inflation is under control, you're not going to necessarily have that clean relationship between stocks and bonds that we had pre-Covid.” It may be many years, he said, before we’re back to those cleaner correlations that lead to more significant diversification.