Pimco’s ‘New Normal’ Thesis Morphs Into ‘New Neutral’Mary Childs
Move over, “new normal.” The “new neutral” is here.
Pacific Investment Management Co., which popularized the term “new normal” to describe an era of below-average economic growth following the financial crisis, says that period is gradually entering a new phase. Economic growth globally will be converging toward lower, yet more stable top speeds and central bank interest rates will remain stuck below their pre-crisis equilibrium in a “new neutral,” Newport Beach, California-based Pimco said in a report today outlining the firm’s expectations for the next three to five years.
“We think of the ‘new neutral’ as a natural evolution from the ‘new normal’,” Executive Vice President Richard Clarida said in a telephone interview, likening the firm’s new outlook to a car stuck in neutral gear. “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.”
Five years after Bill Gross and his former co-Chief Investment Officer Mohamed El-Erian first formalized their vision of a subpar economic recovery, Pimco is refining its view as central banks across the world have been unable to fuel a return to pre-crisis expansion. The new outlook coincides with the departure of El-Erian in March, who alongside Gross had been the public face of Pimco and whose abrupt resignation this year triggered reports of management disagreements at the firm.
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, has struggled in the past year as his $230 billion Pimco Total Return Fund fell behind 87 percent of rival funds. Over the past five years, the fund is beating 58 percent of peers, according to data compiled by Bloomberg.
The new outlook is the outcome of Pimco’s annual Secular Forum, which guides the firm’s world view and investment philosophy over the next three to five years. In the aftermath of the 2008 financial crisis, Pimco used the “new normal” to describe an era of subdued returns, heightened government intervention and increasing clout for emerging nations in the global economy. The term was previously used in a May 2008 Bloomberg News article.
The phrase “new neutral” was coined in a Bloomberg News article in March to highlight how the so-called neutral interest rate -- which neither stimulates nor slows expansion -- is likely to be lower than historically in economies such as the U.S. because of weaker potential growth.
Pimco’s latest thesis maintains the expectations for subpar returns outlined in the “new normal,” although the outlook is more stable compared with what Pimco forecast five years ago. Gross said the “new neutral” focuses more on the outlook for low benchmark interest rates.
“We’re the owner of new normal; we’re not giving it up,” Gross said today in a telephone interview. “The new normal lives, so to speak.”
The market is anticipating a three percent to four percent Fed funds rate in the next three or four years, while Pimco thinks it’s much lower, Gross said today. He is forecasting that the rate would be closer to 2 percent nominally, or zero percent after adjusting for inflation.
“That implies that financial assets, not just bonds but stocks and other financial assets which are probably priced to the same expected high number, may be not as bubbly and as bubblish as some would suggest.”
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, said Clarida, who oversaw the annual forum.
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.”