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The Outlook for the U.S. Economy and Its Financial Markets, and Investment Strategy
Tony Crescenzi
November 2013
pg 1
Agenda
Today’s two main topics and overriding themes:
1) Rising rates 2) “Stable disequilibrium”
Focusing on these themes, we will discuss:
The outlook for interest rates, the U.S. economy, and monetary policy Overview of Japan, Europe, and China and implications for the financial
markets Investment strategy
pg 2
The Interest Rate Outlook
pg 3
September 18th FOMC Meeting Outcome Demonstrates Fed’s Patience on Policy Reversal
At the last FOMC meeting, the Fed persuasively demonstrated its patience toward normalizing its accommodative stance on monetary policy by:
1. Delaying tapering2. Strengthening its forward guidance3. Projecting a 2% federal funds rate at the end of 2016
VariableCentral tendency
for the end of 2016
Longer run
Unemployment 5.4 to 5.9 5.2 to 5.8
Personal consumption expenditures inflation 1.7 to 2.0 2.0Federal funds rate1 2.0 4.0
pg 4
It’s a New Normalization – For Fed Policy
The Fed’s projection for a 2% policy rate at the end of 2016 contrasts sharply with past rate hike cycles
pg 5
Multiple Fed Rate Hikes are Priced In
5
pg 6
Interest Rate Outlook
4.0% Ceiling based on 0% fed funds rate
-1.0% Impact of Fed purchasing programs and forward guidance
-0.8% Impact of potentially diminished GDP growth related to: • Demographic influences• Global debt dynamics • Economic and political uncertainty throughout the world
=2.2% Fair value. Yields are likely to fluctuate in a range between 2.5% to 3.0% until a clearer picture emerges on economic growth in 2014
PIMCO’s assessment of fair value, yield range forecast, and fundamentals driving 10-year yields
pg 7
Interest Rate Outlook
Chart shows month-end spreads as of 30 June 2013. Source: Bloomberg
Treasuries tend to trade at a limited distance to the fed funds rate
pg 8
The Fed’s economic thresholds remain elusive
2cs_TR_review_05 8
As of 31 July 2013Source: Haver Analytics, BEAInflation data is current as of 31 July 2013 and reflect recently released comprehensive revisions to the national income and product accounts published by the BEA every five years to more accurately portray the evolving U.S. economy given improved methodologies and newly available data.
* Year-over-year percentage change in the core personal consumption expenditure deflator
2% inflation target
6.5% Fed policy target
QE1 QE2 Operation Twist and QE3
10.5%
0.5%
2.5%
8.5%
4.5%
3.0%
0.5%
1.0%
2.5%
1.5%
Jun '07 Jun '08 Jun '09 Jun '10 Jun '11 Jun '12 Jun '13
Unemployment rate (LHS) Current inflation (RHS)*
6.5% 2.0%
pg 9
Interest Rate Outlook – Taper Terror
The tale of the taper terror is tame, from a technical perspective, owing to a decline in issuance of both MBS and Treasuries
Pimco calculations
pg 10
Interest Rate Outlook
As of 31 December 2012Source: U.S. Census Bureau, Decennial Census
Baby Boomers began turning 65 in 2011
Numbers of Americans 65 and over
The older people get, they more they tend to favor low volatility in their investments. The working-age population will also grow more slowly and reduce the economy’s growth potential
pg 11
The shrinking pool of safe assets
pg 12
Pick up the Pennies
pg 13
Interest Rate Outlook
Stay cool! Bond market declines have been small and short-lived compared to stock market declines
Core bond funds historically provide:
• Capital preservation
• Steady income
• Potential capital gains
• Liquidity
pg 14
Why bonds now? Hypothetical illustration demonstrates how quickly bond investors get back to even when rates rise
• The Citigroup BIG Index yield to maturity is 2.27%, well above yields of like-duration treasuries
• Reinvestment of income and proceeds at higher yields offsets initial capital loss if rates rise
• For an intermediate bond portfolio, hypothetical seven-year horizon returns generally similar in variety of interest rate scenarios
• Positive impact of reinvesting and compounding in rising rate environment may result in higher returns for long-term investors as compared with stable or falling rate scenarios, given the current low levels of interest rates
• Active management can help enhance returnsSOURCE: Citigroup Yield BookNote: The simulation assumes that for any period observed, the change in rates is spread over that period.
1 Citigroup Broad Investment Grade (BIG) Bond Index, is market capitalization weighted and includes fixed-rate Treasury, Government-sponsored, mortgage, asset-backed and investment-grade issues (BBB-or Baa3) with a maturity of one year or longer. Citigroup Broad Investment Grade (BIG) Bond Index benchmark analysis as of 30 June 2013; Index composition as of 30 June 2013; Index prices, yield to maturity (2.27%) and duration (5.36 years) as of 30 June 2013. The indices and illustrations do not reflect fees that will be charged by PIMCO.
2 Assumes that with no change in interest rates, index return equals initial yields plus estimated impact of “roll-down”.Hypothetical example for illustrative purposes only. No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those shown. Hypothetical or simulated performance results have several inherent limitations. Unlike an actual performance record, simulated results do not represent actual performance and are generally prepared with the benefit of hindsight. There are frequently sharp differences between simulated performance results and the actual results subsequently achieved by any particular account, product, or strategy. In addition, since trades have not actually been executed, simulated results cannot account for the impact of certain market risks such as lack of liquidity. There are numerous other factors related to the markets in general or the implementation of any specific investment strategy, which cannot be fully accounted for in the preparation of simulated results and all of which can adversely affect actual results. The simulation assumes the index portfolio is static despite interest rate movements.It is not possible to invest directly in an unmanaged index.This material contains the current opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2013, PIMCO.
CHANGE IN INTEREST
RATES1-YEAR 2-YEAR 3-YEAR 4-YEAR 5-YEAR 7-YEAR 10-YEAR 30-YEAR
+200 bps (5.78) (0.73) 0.97 1.80 2.27 2.77 3.08 3.36
+100 bps (1.58) 0.99 1.83 2.23 2.46 2.69 2.83 2.90
0 bps2 2.85 2.73 2.69 2.66 2.64 2.61 2.57 2.44
–100 bps 6.82 4.28 3.53 3.17 2.98 2.78 2.65 2.42
–200 bps 9.90 5.50 4.20 3.60 3.27 2.94 2.73 2.41
For use in client servicing SEPARATE ACCOUNT presentations only
2cs_pimco_outlook_11
HYPOTHETICAL ILLUSTRATION OF ANNUALIZED INDEX RETURNS OVER VARIOUS TIME HORIZONS (%)1
pg 15
Beyond duration: Diversified sources of carry
Carry
Credit
Currency
VolatilityYield curve
Duration
Carry is the rate of interest earned by holding the respective securities.
“This may be the most important conceptual change I have ever written about in an Investment Outlook.”– BILL GROSS
pg 16
Pick up the Pennies
Like loose change that falls from your pocket, losses in bonds tend to be small. Replace the pennies lost when rates rise by actively managing the following risk factors:
1. Duration2. Curve3. Volatility4. Credit5. Currency and foreign exposures
Illustration of “picking up the pennies” through yield curve strategy:
Step one: Purchase 5-year T-note yielding 1.55%Step two: Capture price gains from “roll down”: As the security ages, it will “roll down” the yield curve, where rates are lower, resulting in a yield decline/price gainResult: Total return of over 3% (1.55% YTM + 1.50% gain from roll down)
Bottom-line: Diversify sources of “carry” and de-emphasize duration
pg 17
7
8
9
10
11
12
13
Yiel
d (%
)EM valuations have changed
As of 3 October 2013 SOURCE: Bloomberg
IS THERE VALUE IN FIXED INCOME TODAY?
Brazil local 5-year yields
pg 18
PIMCO's fixed income views today
As of 11 March 2013Treasury Inflation-Protected Securities (TIPS); commercial mortgage-backed securities (CMBS); Build America Bonds (BAB)Refer to Appendix for additional investment strategy, outlook and risk information.
3cs_asset_allocation_strat_02
U.S. TREASURIES
CURRENCY
NON-U.S. DEVELOPED MARKETS
EMERGING MARKETS
MORTGAGE-BACKED SECURITIES
INVESTMENT GRADE CREDIT
HIGH YIELD
High Allocation
Minimal Allocation
U.S. Treasuries: Underweight nominal U.S. Treasuries; seek to offset with exposure to real U.S. duration through intermediate to long-term TIPS
Municipals: Maintain existing positions while realizing that tax-exempt municipals reverted to fair value during 2012. Retain existing BABs positions as attractive supply/demand dynamics persist in this market
High Yield: Anticipate increased default risk as Eurozone growth remains weak. Move up the capital structure and seek high quality yield
Mortgage-Backed Securities: Fed buying has contributed to full pricing of Agencies. Position neutral to benchmark and continue to pursue relative value opportunities. Hold non-Agencies and CMBS for additional yield
Currency: Focus short exposure on developed market countries with central banks pursuing QE and focus long exposure on EM
Emerging Markets: Focus on strong balance sheets, positive real yields and countries with scope for further rate declines. Allocate to select emerging markets (EM) corporates and quasi-sovereigns
Curve Positioning: Favor intermediate securities where roll-down potential is most pronounced. Underweight nominal duration at long end of curve
Investment Grade Credit: Underweight the sector and acknowledge the increasing differentiation between credits in terms of default risk
MUNICIPALS
CURVE POSITIONING
Non-U.S. Developed Markets: Focus on countries with healthier balance sheets and independent monetary policy
pg 19
Refer to Appendix for additional investment strategy and risk information.
Finding the sweet spot in corporate bonds
What to own today
U.S. housing
Building materials
U.S. autos
U.S. energy
Asia gaming
U.S. specialty finance
China gas distribution
What to avoid today
Industries vulnerable to rising shareholder activism
Metals and mining
Pharmaceuticals
Telecommunications
Utilities
Longer maturity bonds
pg 20
Pick up the PenniesAlternative approaches to portfolio construction
To fight rising rates and capitalize on the best opportunities, consider absolute return strategies that choose investments on the merits rather than because they are tied to a benchmark index
Emphasize:
• An unconstrained approach that provides latitude for a portfolio manager to choose the most attractive investment opportunities
• Investments having fewer ties to traditional stocks and bonds, including volatility strategies and long/short positions, for example
• Smarter, more dynamic benchmarks that place greater emphasis on fundamentals
• More explicit hedging strategies to combat rising correlations between assets
pg 21
Latest Developments in Japan, Europe, and China
pg 22
China’s growth rate is slowing from its usual 8% to 10% pace
pg 22
A new model of growth is emerging and it is necessary for China to avoid the “middle-income trap”
As of 30 June 2013SOURCE: China National Bureau of StatisticsRefer to the Appendix for additional outlook information.
pg 23
China’s transition from an export-oriented economy is on a grand scale
23
#1. President Xi named military commander-in-chief vs. outgoing President Hu.
#2. President Xi & Premier Li poised to be only members serving full 10 year term.
#3. Politburo Standing Committee reduced from 9 to 7 members.
PolitburoStandingCommittee XiXi
LiLi
LiuLiuZhangZhang YuYu WangWang ZhangZhang
President Xi
As of December 2012SOURCE: Recent announcements by China
pg 24
‐3
‐2
‐1
0
1
2
3
Dec‐93
Dec‐94
Dec‐95
Dec‐96
Dec‐97
Dec‐98
Dec‐99
Dec‐00
Dec‐01
Dec‐02
Dec‐03
Dec‐04
Dec‐05
Dec‐06
Dec‐07
Dec‐08
Dec‐09
Dec‐10
Dec‐11
Dec‐12
Japan Consumer Price IndexYear‐over‐year % change
Japan moving from deflation tolerance to inflation targeting
Japan joins the money-printing reflation bandwagon
As of 31 December 2012Source: Japan Ministry of Internal Affairs, Bloomberg
pg 25
Europe
The ECB’s money printing has alleviated Europe’s debt problem but it can’t solve it
To create debt sustainability, Europe must address its cash flow problem by implementing structural reforms and restoring its:
Growth Competitiveness External balance
Absent actions taken to restore the above, Europe faces continuous risk from these three “R’s”:
Rating Rollover Restructuring
Refer to the Appendix for additional outlook information.
pg 26
The U.S. Economic Outlook –View from the Optimists
pg 27
Fiscal headwinds will diminish
August 2013
The crux of the optimists’ view: If the U.S. economy is growing at ~2% with a ~2% fiscal drag, then why wouldn’t it grow faster in 2014 with <1% fiscal drag?
pg 28
Household net worth has rebounded
As of 31 March 2013SOURCE: Federal Reserve
pg 29
Productivity may rebound
pg 30
Diminishing drag – state and local government
19050
19250
19450
19650
19850
Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12
State and Local Employment(in thousands of workers)
pg 31
Household payment obligations are at their lowest since 1981
15.0
15.5
16.0
16.5
17.0
17.5
18.0
18.5
19.0
Household Financial Obligation Ratio
As of 31 December 2012SOURCE: Federal Reserve
Perc
ent (
%)
pg 32
Housing is recovering
As of 31 December 2012SOURCE: Federal Reserve
pg 33
Shadow household demand
0
1000
2000
3000
4000
5000
6000
7000
8000
9000
1993 1995 1997 1999 2001 2003 2005 2007 2009 2011
Thou
sand
s of
occ
upie
d un
its
Co-Owners or Co-RentersAdult Offspring 30 or Over
2M
Housing: Fundamentals favor increased demand for shelter, including from “mama’s boys”
The rate of new household formations is reverting back to pre-crisis levels of 1.0M -1.5M households per year
The crisis created an additional 800k new households with adult offspring older than 30 years old living with parents, and 1.2M new co-owner or co-renter households
As of 31 December 2011Source: Census, American Housing Survey
33
pg 34
Myth: Banks aren’t lending
As of March 2013SOURCE: Federal Reserve
6600
6700
6800
6900
7000
7100
7200
7300
Aug-10 Feb-11 Aug-11 Feb-12 Aug-12 Feb-13
All Loans & Leases at U.S. Commercial Banks(in billions of dollars)
pg 35
Time for a new car?
CREDIT CONDITIONS HAVE IMPROVEDCARS ARE OLDER
As of 30 September 2011SOURCE: R.L. Polk, Experian Automotive © Edmunds.com, Inc.
753755
762766
773774 775775 776
772769
767766762
740
745
750
755
760
765
770
775
780
1Q 2008 1Q 2009 1Q 2010 1Q 2011
Year
s
AVERAGE CREDIT SCORES –NEW AUTO LOANS
8.0
8.5
9.0
9.5
10.0
10.5
11.0
11.5
Age
in y
ears
Average Age of U.S. Passenger Cars
pg 36
Quarterly bank profits Return on bank assets
Bank capital
Source: FDIC Quarterly Banking Report
Private-sector deleveraging has advanced
pg 37
Headwinds to Economic Activity
pg 38
Big negatives remain:
Headwinds to U.S. growth
WEALTH DESTRUCTION INCOME GROWTH
As of March 31, 2013Source: Federal Reserve and the Bureau of Labor Statistics
pg 39
Credit growth remains impaired
pg 40
The Do-Nothing Congress
Latest session
(2011-2012)
Num
bers
of
law
s pa
ssed
*Note: The 80th session of Congress was in 1947
SOURCE: Washington Post
pg 41
$82
-$15-$65
-$85
-$70-$30 -$10
-$25
-$60
-$120
2010 2011 2012 2013 2014 2015 2016
Estimated Fiscal drag (calendar years)
Expiration of payroll tax cut
Tax increases on upper earnings
Obamacare taxes
Net spending cuts¹
Fiscal drag will decrease, but declines in government spending will remain a headwind
SOURCE: Congressional Budget Office (CBO), PIMCO1 As measured by changes in discretionary spending, which include the net collective impact from the sequester, spending caps and changes in war spending; also includes
cuts to mandatory spending related to the sequester. PIMCO estimates that spending on military operations declines at a faster rate than what the CBO estimates2 Includes multiplier effects; assumes a fiscal multiplier of 0.9 for payroll tax cut, 0.4 for taxes on upper earners, and 1 for spending cuts, which are in line with Congressional
Budget Office and Moody’s estimates
$ Bi
llion
s
-1.25%
-0.05%-0.20%
-0.45%
% of GDP2
% o
f G
DP
-0.4%
-0.1%
0.6%
pg 42
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
0
200
400
600
800
1,000
1,200
1,400
1,600
% of D
GP$
Billi
ons
Spending% of GDP40-year historical averageProjected discretionary spending assuming sequester remains
If sequester and spending limits remain, discretionary spending will fall to near historic lows
SOURCE: Congressional Budget Office (CBO), PIMCO
8.3%: 40-year average
pg 43
Fiscal Policy: Breaking generational promises is difficult, to say the least; For the developed world, it is the transformation of a century
Source: U.S. Library of Congress
The Migrant Mother, 1936 Protestors at the Hellenic Parliament in Athens, Greece, June 2011
pg 44
The Federal Reserve: Objectives, Risks, and Necessity of Current Activism
pg 45
Federal Reserve
Main objectives and investment implications of the Fed’s activist policy regime, which is geared toward smoothing the deleveraging process:
Objectives:
1. Flatten the forward curve2. Reduce interest rate volatility and therefore the term premium in bonds3. Compel investors to move out the risk spectrum
Tools:
I. Zero interest ratesII. Asset purchasesIII. Communications strategies
Risks (from asset purchases):
Remittances – losing money!Market functioning – being too big a player in marketsFinancial stability – spurring excessive risk taking
pg 46
The Fed: “Screaming” for investors to take risk and bid up asset prices
Munch’s “The Scream”$120 million
Babe Ruth’s 1920 road jersey$4.4 million
Source: PIMCO
pg 47
Fed Outlook: Inflation outlook
Q: What do the Fed and Yucca Mountain have in common?
A: They both store toxins
pg 48
Pottersville: What would the world be like if the Fed didn’t exist?
Federal Reserve
48
The nine woeful elements of Irving Fisher’s debt deflation theory of depressions (1933):
1. Debt liquidation leads to distressed selling, which leads to 2. Contraction of the money supply, thereby resulting in3. A fall in the level of prices, and 4. A still greater fall in the net worths of businesses, precipitating bankruptcies and 5. A fall in profits that lead to6. A reduction in output, employment, and trade, all of which lead to7. Pessimism and loss of confidence, and then8. Money hoarding 9. All of the above then result in scarcity of money and therefore an increase in real
interest rates
pg 49
Appendix
Past performance is not a guarantee or a reliable indicator of future results.
RISKInflation-linked bonds (ILBs) issued by a government are fixed income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise.
All investments are subject to risk including possible loss of principle
FORECASTS Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be interpreted as investment advice, as an offer or solicitation, nor as the purchase or sale of any financial instrument. Forecasts and estimates have certain inherent limitations, and unlike an actual performance record, do not reflect actual trading, liquidity constraints, fees, and/or other costs. In addition, references to future results should not be construed as an estimate or promise of results that a client portfolio may achieve.
OUTLOOKStatements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest for the long-term, especially during periods of downturn in the market. Outlook and strategies are subject to change without notice.
HYPOTHETICAL EXAMPLEHypothetical and simulated examples have many inherent limitations and are generally prepared with the benefit of hindsight. There are frequently sharp differences between simulated results and the actual results. There are numerous factors related to the markets in general or the implementation of any specific investment strategy, which cannot be fully accounted for in the preparation of simulated results and all of which can adversely affect actual results. No guarantee is being made that the stated results will be achieved.
This material contains the current opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. There is no guarantee that these investment strategies will work under all market conditions and each investor should evaluate their ability to invest for a long-term especially during periods of downturn in the market. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO and YOUR GLOBAL INVESTMENT AUTHORITY are trademarks or registered trademarks of Alllianz Asset Management of America L.P. and Pacific Investment Management Company LLC, respectively, in the United States and throughout the world. Pacific Investment Management Company LLC, 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2013, PIMCO.
The products and services provided by PIMCO Canada Corp. (199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363, Toronto, Ontario, Canada M5L 1G2, 416-368-3350) may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose.
PIMCO Canada has retained PIMCO LLC (Pacific Investment Management Company LLC , 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626) as sub-adviser. PIMCO Canada will remain responsible for any loss that arises out of the failure of its sub-advisor.
Global Economics & Strategy
Allianz GIobalInvestorsInvestment and Strategy Outlook
November 2013
AGI-2013-11-01-8165
Investment Themes
2Juni 2012
Government Deleveraging Will be A Multi-Year Process
3
Source: IMFAs of: October 2013Past performance is no guarantee of future results. Foreign markets may be more volatile, less liquid, less transparent and subject to lessoversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets. Forecasts and estimateshave certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.
Government Debt-to-GDP Ratios (Actual and Forecasted)*
The debt crisis that has enveloped the developed world was years in the making and it is historic in scale.
For many countries, it will be difficult to bring debt below 90% of GDP—a level above which economic growth is typically impaired.
Three Main Themes of the Global Economy: Financial Repression
0
100
200
300
2000 2002 2004 2006 2008 2010 2012 2014 2016 2018
Deb
t (as
% o
f GD
P)
Japan Greece Italy United States Spain Emerging markets
*Solid lines are actual. Dotted lines are IMF forecasts
Financial Repression is Global In Scope
4Source: FactSet. Bond prices will normally decline as interest rates rise. The impact may be greater with longer-duration bonds.*Europe yields are Germany.
Central Banks Around The World Have Eased Monetary Conditions
Today, with monetary intervention driving both long and short rates to record-low levels, central banks have embarked upon unconventional monetary policy. This has been focused on resurrecting economic growth and it has helped to reduce government financing costs.
Three Main Themes of the Global Economy: Financial Repression
Monetary Easing Should Result In Higher Longer-term Inflation
5Sources: Labor Department; University of Michigan; Allianz Global Investors
US Consumer Price Index
Average inflation over the past 99 years is more than double current levels.
Given the degree of post-crisis monetary easing in the US and abroad, it is unlikely today’s inflation environment will persist longer-term.
Three Main Themes of the Global Economy: Long-run Inflation
1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
-15
-10
-5
0
5
10
15
20
Ann
ual C
hang
e (P
erce
nt)
1.523.303.34
Actual vs Expected Inflation
99-Year Average Consumer Expectations (next 12 months) Consumer Price Index
Economic Indicators Suggest Continued Uneven Global Growth
6
Global Purchasing Manager Indexes: Manufacturing and Service Sector
Monthly purchasing manager indexes (PMIs) are a fair proxy for broader economic activity.
Indicators for global manufacturing and services output remain in expansionary territory, suggesting continued economic growth.
Service Sector Total Manufacturing
Expansion
Contraction
Inde
xThree Main Themes of the Global Economy: Uneven Global Recovery
Source: Factset
Economic Outlook for the US
7
8
US Macro: Current SituationHousing is leading the recovery, with home sales 24% above December 2007 levels. GDP is more than 4% bigger than it was in December 2007. Industrial production and nonfarm payrolls have yet to return to pre-crisis levels.
Source: Datastream
Dec-07 Feb-09 Apr-10 Jun-11 Aug-12 Oct-13
8080
9090
100100
110110
120120
Inde
x
Inde
x
Economic Recovery: Progress Map
Existing Home SalesRetail Sales (nominal)
Consumer PricesGDP (real)
Industrial ProductionNonfarm Payrolls
9
US HousingThe summer QE ‘taper tantrum’ led to the one of the swiftest spikes in mortgage rates in 2 decades. Affordability and mortgage apps have come down sharply. Further monetary support may be needed.
Source: Datastream
2004 2006 2008 2010 2012
4
5
6
7
Mor
tgag
e R
ates
(%)
90
120
150
180
210
Affo
rdab
ility
Inde
x
30 Year Mortgage Rate (Left) National Housing Affordability Index (Right)
1985 1990 1995 2000 2005 2010
40
80
120
160
200
Housing Affordability Index
Housing Affordabil ity Index
2002 2004 2006 2008 2010 2012-20
-15
-10
-5
0
5
10
15
Ann
ual C
hang
e (P
erce
nt)
Home Prices Last: 12.82 (Aug-13)
S&P/Case-Shi l ler - 20 City Price Index
The Housing Recovery has Slowed Amid Higher Prices and Mortgage Rates
10
While housing has been at the forefront of the US economic recovery, higher prices and mortgage rates are weighing on affordability.
Economic Outlook by Region: USIn
dex
Source: Factset
11
US Manufacturing and ServicesUS manufacturing and service sector PMIs remain in expansion territory. Manufacturing conditions are the healthiest since April 2011.
Source: Datastream
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
3535
4040
4545
5050
5555
6060
54.40
56.20
ISM Report on Business Launch full data release
ISM (NAPM) Purchasing Managers Index - United States ISM (NAPM) Non-Manufacturing Index - United States
Recession Periods - United States
12
US ManufacturingManufacturing has been stronger in the US than other countries for most of the past two years. Comparably cheap energy and labor should provide continued support.
Source: Datastream
2006 2008 2010 201260
80
100
120
140
160
Uni
t Lab
or C
osts
(Ind
ex)
US
UK Germany France Spain Japan Italy
China
US Manufacturing Labor Costs Have Become More Competitive
Global natural gas prices
Global manufacturing PMIs underscore US strengthWorld Japan UK Eurozone US Brazil China
Aug‐11 51.2 51.9 49.6 49.0 53.9 46.0 49.9Sep‐11 50.5 49.3 51.1 48.5 53.7 45.5 50.0Oct‐11 50.7 50.6 48.8 47.1 53.6 46.5 51.0Nov‐11 49.6 49.1 47.8 46.4 53.4 48.7 47.7Dec‐11 50.3 50.2 49.1 46.9 53.9 49.1 48.7Jan‐12 51.0 50.7 50.6 48.8 54.3 50.6 48.8Feb‐12 51.2 50.5 50.9 49.0 53.6 51.4 49.6Mar‐12 51.6 51.1 51.9 47.7 56.0 51.1 48.3Apr‐12 51.3 50.7 50.2 45.9 56.0 49.3 49.3May‐12 50.3 50.7 46.7 45.1 54.0 49.3 48.4Jun‐12 49.7 49.9 48.7 45.1 52.5 48.5 48.2Jul‐12 48.8 47.9 45.4 44.0 51.4 48.7 49.3Aug‐12 48.7 47.7 49.5 45.1 51.5 49.4 47.6Sep‐12 48.7 48.0 48.6 46.1 51.1 49.8 47.9Oct‐12 48.8 46.9 47.5 45.5 51.0 50.2 49.5Nov‐12 49.6 46.5 48.9 46.2 52.8 52.2 50.5Dec‐12 50.0 45.0 50.9 46.1 54.0 51.1 51.5Jan‐13 51.5 47.7 50.7 47.9 55.8 53.3 52.3Feb‐13 50.9 48.5 48.0 47.9 54.3 52.5 50.4Mar‐13 51.2 50.4 49.2 46.8 54.6 51.8 51.7Apr‐13 50.4 51.1 50.5 46.7 52.1 50.8 50.4May‐13 50.6 51.5 52.0 48.3 52.3 50.4 49.2Jun‐13 50.6 52.3 52.9 48.8 51.9 50.4 48.2Jul‐13 50.8 50.7 54.6 50.3 53.7 48.5 47.7Aug‐13 51.7 52.2 57.2 51.4 53.1 49.4 50.1
*Readings above 50 indicate expansion
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US Labor MarketWhile the jobless rate has fallen, the decline is partly due to discouraged unemployed workers exiting the labor market. The labor participation rate is at levels last seen during the Carter Administration.
Source: Datastream
1970 1980 1990 2000 2010
4
6
8
10
Une
mpl
oym
ent (
%)
58
60
62
64
66
labo
r Par
ticip
atio
n (%
)
Unemployment and Labor Participation
Unemployment Rate (Left) Labor Participation Rate (Right)
1980 1985 1990 1995 2000 2005 201010
11
12
13
14
Perc
ent
11.92
Household Debt Service Ratio
Max: 14.01 (Sep-07)Min: 10.32 (Dec-12)
Last: 10.49 (Mar-13)
Household Debt Service Ratio Average
1950 1960 1970 1980 1990 2000 20100
20
40
60
80
Per
cent
Total Household Debt (Percent of GDP)
US Household Debt
Consumers have made progress deleveraging. Total debt is at a 9-year low. The debt service ratio—the amount of income required to cover debt costs—is near a record low.
This is a huge relief for consumers, freeing up money for other purposes and offsetting some of the impact from higher payroll taxes.
Consumer Deleveraging has Freed Up Cash For Other Uses
14
Economic Outlook by Region: US
78% (10-year low)
Average
Source: Factset
100%
15
US ConsumerPurchase plans remain standard deviations above normal
Source:Datastream
1970 1975 1980 1985 1990 1995 2000 2005 20100
10
20
30
40
50
Per
cent
pla
nnin
g to
buy
with
in 6
mon
ths
3.405.907.61
12.30
30.82
47.70
US consumer durable good purchase plans are near record highs
Major appliance Average Vehicle Average Home Average
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US Government ShowdownEquity investors are either complacent or don’t believe headline threats of a US default are real/material. The next round of policy hurdles hits next year: on January 15 (federal government funding) and around February 7 (debt ceiling).
Source: Datastream
Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-130
20
40
60
1,100
1,200
1,300
1,400
1,500
1,600
1,700
Debt limit debate results in S&P downgrade for US from AAA to AA+
(August 5, 2011)
Congress passes deal to avert the 'Fiscal Cliff'
(January 1, 2013)
US Credit Risk and Stock PerformanceCorrelation: -0.78
5-Year CDS Spread (Left) S&P 500 (Right)
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US Government ShowdownIf US default is a real and systemic threat, CDS rates in China, Japan and Germany should also be rising. They are not.
Source: Datastream
2004 2005 2006 2007 2008 2009 2010 2011 2012 20130
50
100
150
200
250
300
Bas
is P
oint
s
Credit Default Swap Spreads (5-Year)
China Japan United States Germany
3.08average quarterly GDP since 4q632.67average 4Q GDP since 4Q632.15average quarterly GDP during periods impacted by a gov shut down!
18
US Government ShowdownGov shutdowns typically hit GDP harder than share prices. This is particularly notable in light of optimistic expectations for 4Q13 earnings and the not-fully reported damage from the summer spike in borrowing costs.
Source: Datastream
Government shutdowns tend to have a greater impact on GDP
than share prices
19
US Government ShowdownFiscal stress will likely continue. The Congressional Budget Office projects US budget deficits for the foreseeable future. The US debt-to-GDP ratio may remain near historic highs. Investors should prepare for a long period of financial repression.
Source: Datastream
-8
-6
-4
-2
0
2012 2014 2016 2018 2020 2022
Perc
ent o
f GD
P
Annual Budget Deficit Forecasts*
69
72
75
78
81
2012 2014 2016 2018 2020 2022Pe
rcen
t of G
DP
(Net) Debt Forecasts*
*Note: Assumes full sequester comes into force
20
US Monetary PolicyMost Fed policymakers don’t anticipate the first increase in the fed funds target rate until 2015 (as of September 17-18 FOMC meeting)
Source: Datastream
21
US Monetary PolicyThe Fed’s balance sheet continues to increase to new highs as QE progresses. The Fed is now the largest single owner of US public debt. The IMF has identified QE unwinding as a global threat. When it occurs, interest rates may rise, putting bond investors at risk.
Source: Datastream
22
S&P 500 Earnings Update3Q13 estimates are down $0.42 since June 28. Estimates for 4Q13 are at record highs and starting to come under pressure. If share prices don’t fall in tandem, lower estimates make shares look more expensive.
Source: DataStream
Big earnings increase projected for 4Q13So far, 3Q13 earnings
have come in 1.4% above estimates. This is the
weakest since 4Q08 and largely due to legal expense charge at JPMorgan Chase.
Companies are in Better Shape from a Leverage Perspective
While the federal government has been levering up following the financial crisis, the private sector has been delevering and stockpiling cash on its balance sheets.
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While the federal government has been levering up following the financial crisis, the private sector has been delevering and stockpiling cash on its balance sheets.
Source: Factset, Datastream; Allianz Global Investors Economics & Strategy as of 12/31/12
24
US Macro: ForecastWe expect the US to grow 2.5% in 2014. That is faster than any other developed economy except the UK. Inflation should remain tame and long Treasury rates should continue a slow climb to 3.25% by the end of 2014.
Source: Datastream
Economic Outlook for the Globe
25
Fears Have Eased But Risks Remain
26
While new flare-ups are possible, systemic threats to Europe’s currency union have eased.
A big jump in German bank holdings is reversing, as investors become more comfortable keeping assets in Spain and Italy.
Target2 Bank Balances
Source: Factset
Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13
4
8
12
Per
cent
10
20
30
Per
cent
Spreads: 10-year government bonds to German Bunds
Portugal Spain Italy Greece (rhs) Ireland
Europe is Out of Recession, But Not Out of the Woods
27
The euro zone’s longest recession ended this summer. Yet challenges remain. Unemployment regionally is at 12%. Joblessness in Spain and Greece is comparable to levels seen during the Great Depression in the US.
Austerity appears to have had a negative impact on economic growth.
Unemployment Rates
Retail Sales
Source: Factset
2004 2005 2006 2007 2008 2009 2010 2011 2012 20135
10
15
20
25
Per
cent
Greece Spain Italy Germany
Oct-11 Jan-12 Apr-12 Jul-12 Oct-12 Jan-13 Apr-13 Jul-13 Oct-13-20
-10
0
10
Annu
al P
erce
nt C
hang
e
Germany France Ireland Italy Spain Greece
Japan is The Frontline In Global Monetary Easing
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Japan Monetary Policy
In December 2012, Prime Minister Shinzo Abe won national elections in Japan.
His pro-growth economic platform, ‘Abenomics’, has resulted in higher stock prices, a weaker yen and plans to more than double the size of the Bank of Japan’s asset purchase program (QE).
2012 Elections - Impact on Nikkei and Yen
Source: Factset
Oct-12 Jan-13 Apr-13 Jul-13 Oct-13
80
100
120
140
160
180
Inde
x
Prime Minister Noda announces plans for
new elections
2012 Elections - Impact on Nikkei and Yen
Nikkei 225 Index US Dollar per Yen
Jan-04 Jan-06 Jan-08 Jan-10 Jan-12-40
-20
0
20
40
Ann
ual C
hang
e (%
)
Exports Retail Sales Industrial Production
China remains comparably healthy
29
China remains the fastest-growing large economy in the world. While exports have slowed, as of September 30, retail sales and industrial production were growing at a more than 10% annual pace.
The country’s new leadership has said it will continue pursuing pro-growth policies.
Real GDP Growth/Contraction
Economic Indicators
Source: Factset
2000 2002 2004 2006 2008 2010 2012
-6
-3
0
3
6
9
12
China India United States Japan Germany Brazil United Kingdom
Portfolio Positioning
30
Score overview: Our portfolio positioning
Source: Allianz GI, portfolio positioning can change on a regular basis. We assume no obligation to update any forward-looking statement. 31
User guide:
Score can be positive (right from the red neutral line, max. +4) or negative (left, max. -4).
Scores for trend, economics and valuation are determined across asset classes as a starting point for determination of single asset class scores.
Single asset class scores should be interpreted as an assessment of the absolute attractiveness of an asset class compared to its historic risk/return profile.
The portfolio score (right column) is the result of an optimization process and should be interpreted as active weights which sum up to zero across a multi asset portfolio.
Yellow shades. Direction of most recent changes.
We stick to overweight positions in developed equities and high yield bonds.
As of October 4, 2013
Important InformationInvesting involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. Stocks can be volatile and, unlike bonds, do not offer a fixed rate of return. Investments in smaller companies may be more volatile and less liquid than investments in larger companies. Investments in emerging markets may be more volatile than investments in more developed markets. Dividends are not guaranteed. Bonds are subject to interest rate risk and the credit risk of the issuer. High‐yield or “junk” bonds have lower credit ratings and involve a greater risk to principal. Convertible securities involve the added risk that securities must be converted before it is optimal. This is a marketing communication. It is for informational purposes only. Investments in commodities may be affected by overall market movements, changes in interest rates, and other factors such as weather, disease, embargoes and international economic and political developments. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.
The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.
Allianz Global Investors is the marketing name of our global asset management business, which operates through affiliated entities worldwide. Allianz Global Investors affiliated entities include: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors Europe GmbH, an investment company in Germany, authorizedby the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); RCM (UK) Ltd., which is authorized and regulated by the Financial Services Authority in the UK; Allianz Global Investors Hong Kong Ltd. and RCM Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator; Allianz Global Investors Korea Ltd., licensed by the Korea Financial Services Commission; and Allianz Global Investors Taiwan Ltd., licensed by the Financial Supervisory Commission in Taiwan
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