An interview with PIMCO CIO , Global Equities - Virginie Maisonneuve, and equity macroeconomic analyst - Mark Richards
Q: What are the key themes that global equity investors should focus on in 2015?
A: One important aspect of the global economy in its normalization path after the financial crisis continues to be the multi-speed world. This has broad consequences for divergent monetary policy in major economies and the related effects on global currencies. Lower oil prices also have different consequences for various economies in terms of growth, inflation and the potential for at least temporary deflation in some major economies, especially when combined with a strong dollar. These factors are at play amid an ongoing shift in global geopolitics. So while our New Neutral forecast calls for a low interest rate environment for longer and subdued growth globally, we think that external shocks and heightened investor sensitivity to them create an environment that may foster bouts of volatility. We believe this will actually present opportunities to gain select equity exposure at inexpensive valuations.
Q: How will central bank policy divergence affect global equity markets?
A: Major global central bank policies are going in different directions, with the Federal Reserve likely to start normalizing its interest rate stance first and the European Central Bank (ECB) and the Bank of Japan (BOJ) likely to continue to provide easier policy through 2015. The threat stemming from deflationary forces, slow growth in Europe and Japan and decelerating growth in China is likely to keep central bank policy in these regions extremely loose. This is in contrast to the U.S., where growth is stronger, the labor market is improving and the Fed views lower energy prices as having a “transitory” impact on inflation. In aggregate, we believe that liquidity will remain supportive in 2015. One of the questions for 2015 is: Could bad news ultimately be good news for equity markets as it may translate into slower interest rate normalization and more aggressive quantitative easing (QE) policies? For instance, in Europe, growth is expected to remain subdued and fears of deflation are expected to be realized (albeit only in headline inflation). That said, new, aggressive QE programs would provide a potentially positive backdrop for select equities, particularly as valuations are more attractive than in the U.S., with a widening of the equity risk premium. In Japan, additional BOJ easing in October and Prime Minister Abe’s election victory are likely to keep both the reform agenda on track and downward pressure on the yen, which should be a tailwind for earnings. A weaker yen and euro should provide support to European and Japanese exporters. Still, we will be watching closely the efficacy of ECB and BOJ policy.
Q: PIMCO sees the drastically lower price of oil as the most important factor driving the global economy over the next year. How will it affect equity investors?
A: The plunge in oil will have a broadly supportive effect for many countries and companies over the coming year, but not all will benefit. Because we believe the drop is largely supply driven, with an element of weak demand too, we think that overall it is a tailwind for the global economy. The decline will be more supportive for net large oil importers and consumers and negative for countries that are highly dependent on oil revenue. China and Japan, large net importers, will benefit, as will other Asian net importers such as Korea, India and Thailand. Consumers in countries that benefit from weaker oil prices or where the pass-through from lower crude oil prices to the petrol pump is swift will benefit the most. On the other hand, Russia and Norway whose economies are largely oil-dependent will suffer. Similarly, countries and companies that have benefited from an aggressive energy capex cycle will be vulnerable.
Q: Are lower oil prices expected to exert disinflationary pressures around the world? How should equity investors think about that?
A: In an environment with disinflationary forces, it is extremely important to think about a company’s or a sector’s pricing power. In most developed countries, headline inflation readings are likely to go negative this year: If containable, this development can actually be supportive for their economies as it will likely act as a boost to households’ real disposable income and potentially encourage central banks, particularly the ECB and BOJ, to continue to be aggressive. In Europe, high structural unemployment remains a concern, and Japan is struggling to emerge from years of deflation. In the U.S., while headline inflation will also likely go negative temporarily, policymakers may be more focused on better growth and an improving labor market. It is worth noting that we do not expect underlying inflation to turn negative. At any rate, in this environment, pricing power will be an essential component for improving earnings and a critical determinant of stock selection for our portfolios. Pricing power can insulate a company from the effects of low or negative inflation, which may even simultaneously lower their production costs. Generally speaking, we believe parts of the technology sector, selected industrials and certain consumer sectors, such as autos and travel and leisure, will be able to maintain pricing power while sectors such as retail and commodities are in a weaker spot. A period of sustained deflation, such as Japan experienced, would be a clear negative for financials and helps to explain the lackluster performance of Euro area banks in 2014.
Q: Emerging markets (EM) have taken a hit over the past year. What is your view?
A: It is fair to say that from a relative valuation perspective, EM appears cheap versus its history and versus the developed markets, and it also offers marginally better growth prospects, according to consensus estimates. However, as we have seen many times, it’s a much more volatile asset class than developed markets, and is likely to be vulnerable as the U.S. begins to raise rates and the dollar continues to strengthen. There is also a more important point: EM should not be viewed as a single asset class. For instance, the oil-producing countries are in a very different position and will experience sharply different dynamics in 2015 than the net oil importers, such as China, Taiwan or Korea, who will have a comparative tailwind. EM has become more fractured, and investors need to be able to identify the countries that will benefit more or be hurt less by evolving global dynamics; they will also need the fortitude to buy good companies during times of volatility.
Q: The wild card: market-moving geopolitical events. What are your thoughts and are there opportunities?
A: Geopolitical risk is shifting rapidly while the general mindset is still to think along the lines of the framework developed during the 20th century. This shift could come as a surprise to global participants. Following the financial crisis, not only is it clear that most countries have seen some significant political or structural change, but also that the global backdrop has altered. Rising global fragmentation as a result of economic, cultural, sociological and technological shifts is important. However, like tectonic plates, which move slowly, these shifts are often imperceptible until triggered by specific events. For example, the lower price of oil, which is linked to technological advances in terms of energy efficiency, exploration and production – as well as competition for market share by major producers – is redefining some of the world’s traditional power bases. The slow but perceptible isolation of Russia and its shift toward the east is one of them. The political impact of a sustainably lower oil price on the Middle East is another. China’s maturing economic profile is not yet matched by its geopolitical and military influence, but this will change. This, in turn, might also support shifts within Japan in light of weak economic growth and an ageing population. The rise in extremist political parties and/ or populist government in Europe, where regional disparities are still pronounced, is also important. The list goes on. And there are new global challenges such as the rise of ISIS and cyber-terrorism. So while there are very real improvements and challenges for global economic growth in the ongoing recovery from the financial crisis, there is also potential for headline events that may provoke sharp market moves. At PIMCO, our goal is to be both rigorous and nimble, and build equity portfolios that can withstand times of stress, while maintaining our long-term outlook and always seeking to buy good companies with positive long-term earnings growth prospects. We want to offer our clients a diversity of investment styles and strategies geared to provide diversity and stability through different market environments. And that is what we will be focusing on once again in 2015.