‘Heaven and Hell’ Now Perfectly Priced in Markets, Pimco Warns
‘Heaven and Hell’ Now Perfectly Priced in Markets, Pimco Warns
(Bloomberg) -- The U.S. and China may have reached a truce, but investors have plenty of other conflicts to worry about.
The sugar high spurred by this weekend’s agreement to restart trade talks is fading fast, focusing the minds of money managers caught between assets at war.
Markets are pricing both the best- and worst-case market scenarios, handing a conundrum to those riding the melt-up in everything: Pay up for defensive strategies, bet on more gains, or lock in the 2019 windfall.
“We had a rally in both risk-free and risk assets,” said Geraldine Sundstrom, portfolio manager at Pacific Investment Management Co. “Both are priced to perfection. We have a fixed-income market priced in between heaven and hell.”
For heaven, read a combination of dovish monetary policy and trade-war resolution that gives the business cycle extra juice. For hell, brace for a prolonged trade war, faltering growth and impotent central bankers.
Faced with the divided outlook, Pimco is mildly underweight equities with a preference for quality stocks, favors more liquid, higher-quality credit and is keeping back cash for dip-buying opportunities.
Bond ‘Excess’
Bond investors made their bet in the first half, and were rewarded with a whopping return as President Donald Trump escalated protectionist spats with China, Europe and Mexico. That amplified slowdown fears and wagers for easier monetary policy.
But the trade is no longer so simple. Economic data are sending mixed signals and market expectations for Federal Reserve rate cuts look extreme. Both Barclays Plc and Goldman Sachs Group Inc. have turned underweight Treasuries on signs the rally is exhausted, while BlackRock Inc. called recent yield moves “excessive” and urged patience before boosting exposure.
“We see many of the supposed safe havens as offering a period of return-free risk rather than risk-free returns,” said Will Hobbs, chief investment officer at Barclays Investment Solutions in London. He reckons the resilience of the U.S. private sector “should act as a significant barrier to the darker economic times already assumed by large chunks of the government bond complex, and indeed wider safety or quality trades.”
The bond fears certainly look acute. According to a JPMorgan Chase & Co. model, the S&P 500 is assigning zero odds to the chance of a recession within one year, and U.S. junk bond spreads indicate just an 8% likelihood. The Treasury market puts the probability at 62%.
Meanwhile, the world’s pool of negative-yielding debt remains near a record thanks to insatiable investor demand for safe assets. Those yields are fair value if you assume a new round of monetary stimulus is coming and recession risks are rising. If the Federal Reserve and European Central Bank disappoint ultra-dovish expectations, however, bulls could be braced for losses.
Stocks’ Take
Equities made a comeback in June, buoyed by softer monetary rhetoric and trade optimism. In a sign of growing investor confidence, U.S. small-caps outperformed large-caps and weaker balance sheet stocks beat firms with stronger financial positions.
“The markets want to have their cake and eat it,” said Jon Cunliffe, chief investment officer at Charles Stanley in London, which oversees about 24 billion pounds ($30 billion) in assets. “They want to see some sort of resolution to the trade war and a significant amount of Fed cuts.”
The trouble is, genuine progress on trade would reduce the need for monetary easing. “As a consequence, there’s less upside in risk assets over the balance of the year,” he said.
In credit, investors can collect 367 basis points more than Treasuries to buy U.S speculative-grade rated bonds, according to Bloomberg Barclays index data. That’s 74 basis points below the five-year average.
In fact, the gap between high-yield spreads and the one-year U.S. recession probability forecast is near the widest since the financial crisis, according to a Bloomberg model.
All eyes are now on economic data as traders search for clues on what’s next. Global manufacturing took a hit at the end of the second quarter, signaling a worsening economic growth outlook. In the U.S., IHS Markit’s PMI was better than a preliminary reading, but still near a decade low.
“From here, it’s all about growth,” said Mike Bell, a global market strategist at JPMorgan Asset Management. “We’re talking to clients at the moment about being neutral risk. Given that it’s possible that you get this reacceleration in growth, it doesn’t make sense to have big underweight positions. On the other hand, if data continue to deteriorate, being overweight risk assets like equities and credit could be a risk.”
To contact the reporters on this story: Ksenia Galouchko in London at kgalouchko1@bloomberg.net;Cecile Gutscher in London at cgutscher@bloomberg.net
To contact the editors responsible for this story: Blaise Robinson at brobinson58@bloomberg.net, Samuel Potter, Sid Verma
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