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Speaker 1: We begin with the big issue, the after shock economy,

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Speaker 1: Pincos's second rountlook, indicating that markets will likely face more

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Speaker 1: volatility as the global economy exits a period of massive

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Speaker 1: fiscal and monetary support. What a fantastic way to kick

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Speaker 1: off the next sixty minutes with the PIMCO Chief Investment

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Speaker 1: Officer Dan Iverson.

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Speaker 2: Good morning to you, Dan, Good morning John.

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Speaker 1: I can't believe it's been four years since we did

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Speaker 1: this last time around. The last four years has been

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Speaker 1: an absolute blur. Let's just start with the title of

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Speaker 1: this new piece, and thanks for having us, of course,

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Speaker 1: what is the after shock economy?

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Speaker 2: Sure?

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Speaker 3: What we're getting out here, and you suggested it in

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Speaker 3: your opening comments, is that we've had massive disruption over

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Speaker 3: the course of the last four years or so. Going

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Speaker 3: into that period, we had record low interest rates. I

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Speaker 3: think back in twenty nineteen, eighteen trillion dollars or so

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Speaker 3: of negative yielding assets, a global pandemic, record stimulus and inflation,

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Speaker 3: and now over the course of the last five quarters

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Speaker 3: we've had about five hundred basis points of central bank tightening.

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Speaker 3: It's beginning to the impact the economy. So we look

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Speaker 3: at the world and look at the types of shocks

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Speaker 3: that we felt the last few years. We think there's

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Speaker 3: going to be volatility ahead. We think we're at a

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Speaker 3: unique time for markets now where there's been a tremendous

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Speaker 3: amount of tightening injected into the system, and you're dealing

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Speaker 3: with the period now where we expect to begin to

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Speaker 3: see the economy slow, certain segments of the economy surprised

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Speaker 3: to the downside. It's going to lead to ongoing volatility.

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Speaker 3: We've experienced it in fixed income. We expect that volatility

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Speaker 3: to work its way into equity markets and it's going

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Speaker 3: to create some challenges but also opportunities for end investors.

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Speaker 1: Well, we'll talk about the opportunities in just a moment.

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Speaker 1: Reading through the piece, fantastic hassay, but something stands out

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Speaker 1: for me. You've gone through the differences between now and

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Speaker 1: maybe the pre pandemic world. Yet within the piece, there

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Speaker 1: is still a call for a return to target inflation

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Speaker 1: at central banks, including the Federal Reserve here in the

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Speaker 1: United States.

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Speaker 2: There is also a.

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Speaker 1: Call in there about going back to low real neutual

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Speaker 1: interest rates.

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Speaker 2: What's changed that's right now.

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Speaker 3: We don't necessarily think we get back to the levels

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Speaker 3: that we saw pre COVID. But we do think real

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Speaker 3: interest rates will normalize somewhere in that zero to one

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Speaker 3: percent range, perhaps a bit higher again than what we

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Speaker 3: grew accustomed to for much the last decade. And inflation,

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Speaker 3: although we do expect in the base case for inflation

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Speaker 3: to trend back down towards central bank targets, it too

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Speaker 3: is likely to be much more volatile going forward. The

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Speaker 3: balance of risks will be more symmetric going forward. So

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Speaker 3: no longer do we live in a world where there's

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Speaker 3: almost constant disinflationary pressure and a goal and desire from

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Speaker 3: central banks to stimulate the economy to get back to target.

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Speaker 2: So again we.

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Speaker 3: Are constructive in the sense that we take central banks

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Speaker 3: seriously in terms of their desire to get inflation back

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Speaker 3: towards target. We think eventually they will get inflation back

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Speaker 3: down towards target.

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Speaker 2: But over the next five.

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Speaker 3: Or even ten years, we're going to be in a

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Speaker 3: very very different world than the world we're in pre COVID,

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Speaker 3: where again, these types of risks that were well contained

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Speaker 3: for an extended period of time and led to a

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Speaker 3: certain type of risk seeking behavior by end investors is

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Speaker 3: likely behind us, and we're going to be in a

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Speaker 3: more uncertain world, a less synchronized world, in a world

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Speaker 3: that's going to create, you know, a tremendous amount of

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Speaker 3: opportunity to take advantage of shifting opportunities across the global

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Speaker 3: opportunity set.

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Speaker 1: Well, let's talk about those opportunities right now. Where are

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Speaker 1: they for you?

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Speaker 2: Well, right now, we are a bit cautious.

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Speaker 3: As we mentioned earlier, there's about five hundred basis points

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Speaker 3: of stimulus that have occurred in record amounts of time.

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Speaker 2: This is an economy.

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Speaker 3: Where lags are likely longer than they have during prior cycles.

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Speaker 3: The household, as an example, has been able to turn

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Speaker 3: out debt at record low levels fixed rate debt, so

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Speaker 3: they're failing less of an impact from central bank policy.

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Speaker 2: But trouble is ahead. There's been massive growth.

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Speaker 3: In certain segments of the market, private credit, senior secured loans,

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Speaker 3: all of which float to the funds rate, so to speak,

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Speaker 3: and are feeling the full brunt of tightening. So over

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Speaker 3: the next couple of quarters we do expect to see

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Speaker 3: more signs of an economic slowdown. The good news, of course,

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Speaker 3: is that we've got a massive repricing and fixed income,

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Speaker 3: so we think today you know, In terms of putting

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Speaker 3: together a portfolio, investors should focus on the public opportunity

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Speaker 3: set up in quality, and that can mean things like

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Speaker 3: agency mortgage backed securities that are trading at record widespreads.

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Speaker 3: Also some of the higher quality, war resilient areas of

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Speaker 3: the credit opportunity set, we would be much more reluctant

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Speaker 3: and we are much more cautious moving into the more

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Speaker 3: economically sensitive areas of the investment opportunity set right now,

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Speaker 3: and that means underweights to loans, underweights to some of

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Speaker 3: the weaker segments of the corporate credit markets.

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Speaker 1: This is a fixed income house, but within the pace

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Speaker 1: this morning, there is a cool inequities. You do make

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Speaker 1: the point that you don't believe the equities were appropriately

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Speaker 1: discounted the world that you're anticipating.

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Speaker 2: What is it you see that that's correct?

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Speaker 3: I think starting with volatility, there's been massive volatility in

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Speaker 3: the fixed income markets. You look at implied volatilities and

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Speaker 3: fixed income they remain quite elevated. Equities have traded very

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Speaker 3: well recently. The VIX index is down again in the

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Speaker 3: fifteen handle type range. So we do think that within

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Speaker 3: the equity markets there's a bit more complacency. We believe

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Speaker 3: as we move forward in time in this tightening and

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Speaker 3: policy begins to impact the economy with a lag, you

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Speaker 3: are going to begin to see some earnings pressure within

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Speaker 3: the equity markets. You're going to continue to see and

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Speaker 3: this is going to occur almost in slow motion, continued

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Speaker 3: pressure on corporate credit fundamentals.

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Speaker 2: So as a starting.

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Speaker 3: Point today, when we look at the fixed income markets,

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Speaker 3: you look at the yields in the front end of

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Speaker 3: the curve, where you can put together a high quality

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Speaker 3: portfolio yielding six seven eight percent, even slightly higher than that,

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Speaker 3: we think that's a very very attractive relative return. More

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Speaker 3: cash flow certainty, more predictability, even historically, that's a very

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Speaker 3: very attractive return. We think equities at these starting valuations

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Speaker 3: are likely to struggle as we see more sides of

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Speaker 3: an economic slow down, and I think at that point

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Speaker 3: in time, fixed income not only can provide an attractive yield,

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Speaker 3: but also some price appreciation potentialists.

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Speaker 1: Within equity markets, there is a big hope and a

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Speaker 1: prayer on AI, and the productivity story around AI perhaps

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Speaker 1: runs counter and against your base case to your central case,

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Speaker 1: and a second outlook that we can end up with

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Speaker 1: this massive productivity boom. Do you think maybe this and

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Speaker 1: I'll phrase this question in my way and you can

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Speaker 1: push back if you're deem it appropriate, do you think

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Speaker 1: there is a one hundred and fifty percent rally at

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Speaker 1: a single name right now that runs counter to your

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Speaker 1: secular outlook.

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Speaker 3: Well, we are quite positive about AI as a technology.

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Speaker 3: We've been spending a lot of time thinking about AI

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Speaker 3: and already doing a lot of research in terms of

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Speaker 3: how it can impact our business, and we're optimistic that

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Speaker 3: there could be areas where AI could be quite enhancing

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Speaker 3: from a productivity perspective. So there's certainly going to be

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Speaker 3: winners in the stock market and losers associated with this

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Speaker 3: new technology and the disruptive nature of this technology. Now,

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Speaker 3: as a fixed income investor, disruption is not always a

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Speaker 3: good thing. You better hope you are investing in credits

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Speaker 3: that are not going to be disrupted by this technology.

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Speaker 3: So we acknowledge this in our research piece that this

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Speaker 3: is a significant wildcard, and if AI gets implemented in

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Speaker 3: a manner that some think it may, this could lead

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Speaker 3: to a sustain period of higher productivity. Of course, there's

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Speaker 3: lots of other factors pushing productivity lower and even product

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Speaker 3: at the economy level isn't necessarily a great thing for

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Speaker 3: financial markets, particularly fixed income, where at best you earn

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Speaker 3: your coupon and you get par back at the end

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Speaker 3: of the day. So the way we're thinking about AI

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Speaker 3: is it's an important technology, it's a disruptive technology. We're

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Speaker 3: assessing its impact from a macro perspective, but even more importantly,

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Speaker 3: very focused on how it may disrupt the companies we

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Speaker 3: invest in, the other business models we support across our business,

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Speaker 3: where again you better be sure that you're on the

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Speaker 3: right side of the disruption. And again one of the

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Speaker 3: reasons we do believe that the next few years is

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Speaker 3: going to be much more volatile, more credit losses that

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Speaker 3: we've grown accustom to, and just more within sector and

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Speaker 3: a cross sector volatility associated with what we think at

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Speaker 3: a minimum is going to be highly disruptive. It very

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Speaker 3: well could be the type of game changing technology that

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Speaker 3: does lead to more sustained, higher product.

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Speaker 1: Can we just go through the pockets of risk right

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Speaker 1: now that you are the risking around great pain is

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Speaker 1: a pagem was on the program with my colleague Laser

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Speaker 1: a little bit earlier this morning, and he talked about

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Speaker 1: how some of the risk could move away from high

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Speaker 1: yield to loans and into private markets. Is that how

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Speaker 1: you feel about where the risk is right now and

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Speaker 1: are you pulling back from those areas?

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Speaker 3: Yeah, we agree with that. It's quite remarkable. We were

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Speaker 3: in a very very low interest rate period for a

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Speaker 3: long time. You end up with the COVID shock where

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Speaker 3: rates hit new lows and you had households people with mortgages,

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Speaker 3: significant portions of the investment grade and the high yield

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Speaker 3: universe termed their debt out at record low levels and

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Speaker 3: by themselves multiple years of cushion to deal with the

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Speaker 3: weak economy. On the flip side, two of the fastest

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Speaker 3: growing sectors since the GFC. We're senior secured loans in

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Speaker 3: private credit one hundred percent floating rate markets, which made

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Speaker 3: some sense when rates were low and anticipated to never

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Speaker 3: go materially higher. That entire sector today is filling the

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Speaker 3: full brunt of central bank policy. Those companies are forced

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Speaker 3: to pay higher and hire debt service coverage into what

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Speaker 3: we expect.

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Speaker 2: To be a weakening economy.

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Speaker 3: We don't think this is systemic, like the challenges in

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Speaker 3: subprime back PREGFC, but those are two sectors that are

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Speaker 3: going to be challenged. They really haven't been challenged for

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Speaker 3: a sustained period before. We do think there's going to

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Speaker 3: be disappointment there. There's going to be losses, the need

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Speaker 3: to restructure debt. Stay away from those sectors today until

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Speaker 3: they reprice The other factor they have are very very

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Speaker 3: sticky marks relative to what you get in the public space.

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Speaker 3: But we think this is going to be a phenomenal

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Speaker 3: opportunity for new capital over the course of the next

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Speaker 3: few years. So bottom line, stay defensive today, stay in

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Speaker 3: the IG sector, stay in the high yield sector, but

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Speaker 3: be poised to use some of that liquidity over the

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Speaker 3: course of the next five years to take advantage of

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Speaker 3: what are going to be significant challenges within that space.

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Speaker 3: And again, this is moving at very very slow motion

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Speaker 3: because you don't see the price response like you see

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Speaker 3: in segments of the public opportunity set.

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Speaker 1: Well, talk to me about what a cash allocation should

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Speaker 1: look like in anticipation of that and if you can

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Speaker 1: throw it in there too. Are you thinking about a

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Speaker 1: point on the calendar where you think this starts to bite,

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Speaker 1: because I feel like over the last twelve months people

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Speaker 1: have made at this point and just keep pushing.

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Speaker 2: It out, pushing it out.

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Speaker 1: It's going to happen, but maybe next year.

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Speaker 2: Yeah.

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Speaker 3: So we've looked back at tightening cycles since nineteen fifty

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Speaker 3: and again a wide range of outcomes during these different periods,

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Speaker 3: but typically it's about five quarters before you see the

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Speaker 3: impact from tightening on the broad economy.

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Speaker 2: We're right at that point today.

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Speaker 3: Again, we've had record amounts of tightening over that fifteen

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Speaker 3: month range, so we would expect going into year end,

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Speaker 3: in perhaps throughout twenty twenty four, steady deterioration in some

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Speaker 3: of these fundamentals. So today, from the cash allocation perspective,

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Speaker 3: we love value in high quality bonds, particularly bonds priced

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Speaker 3: off of the front of the yield curve I mentioned earlier.

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Speaker 3: You could stay in very very liquid, high quality investments

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Speaker 3: generate six seven percent.

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Speaker 2: Nothing wrong with cash here.

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Speaker 3: I think it's good to make sure you're earning a.

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Speaker 2: Full yield on your cash.

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Speaker 3: But we think cash makes a lot of sense alongside

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Speaker 3: high quality bonds, and that gives you the liquidity and

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Speaker 3: the flexibility to shift into what will likely be a

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Speaker 3: very reattractive opportunity in private credit. In commercial real estate,

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Speaker 3: we didn't talk much about that today. But that's another

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Speaker 3: sector that's moving somewhat in slow motion, but where we

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Speaker 3: expect there to be some challenges and therefore opportunities over

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Speaker 3: the course of the next few years.

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Speaker 1: In the last ten minutes, I've heard a lot about

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Speaker 1: being at the front end liquidity. I've heard a lot

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Speaker 1: about risks on the horizon and the economy for earnings.

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Speaker 1: I've heard very little about taking on more duration. Why

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Speaker 1: am I not hearing that? Why isn't this the moments

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Speaker 1: by a tenure at three seventy and anticipate this big

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Speaker 1: treasury market rally.

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Speaker 2: Well, it's not a bad idea.

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Speaker 3: I think the good news given the massive repricing and

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Speaker 3: fixed income, is that you don't have to take a

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Speaker 3: tremendous amount of interest rate risk in order to generate

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Speaker 3: attractive returns. I think that may be, you know, a

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Speaker 3: sense of nervousness in the market. Fixed income and duration

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Speaker 3: in generals have performed so poorly over the last few years.

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Speaker 2: People are nervous.

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Speaker 3: Yeah, But the key point here is that you know,

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Speaker 3: across pimical mandates, we're operating near neutral duration across our strategies.

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Speaker 3: In some strategies even a little bit defensive underway in

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Speaker 3: still generating those yields I mentioned earlier, mid to high

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Speaker 3: single digit type returns while being able to be a

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Speaker 3: bit insulated or a lot insulated from interest rate risk.

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Speaker 2: So we don't dislike taking on duration here.

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Speaker 3: We just think you can put together a high quality

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Speaker 3: fixed income portfolio without needing to take a lot of

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Speaker 3: interest rate risk. If we see rates a bit higher

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Speaker 3: from here, if we see signs of further deterioration in

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Speaker 3: the economy, we will look to extend those durations.

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Speaker 2: Our durations are a lot.

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Speaker 3: Longer today than where they were just a couple of

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Speaker 3: years ago, so we're moving in that direction, but we

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Speaker 3: still want to provide resilient portfolios.

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Speaker 2: Inflation still remains elevated.

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Speaker 3: Central banks continue to be active, so we think they're

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Speaker 3: on the interest rate side, just be a little bit

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Speaker 3: defensive as well. The markets have done the work for us.

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Speaker 3: We finally have value back in the market. Sit back

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Speaker 3: and earn your coupon and get a little bit of

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Speaker 3: appreciation if we end up in a harder landing city.

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Speaker 1: It just the final one from me, Dan, because we've

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Speaker 1: got a whole host guest in front of us where

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Speaker 1: we can talk about things like commercial real estate and

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Speaker 1: credit mark So, coming up a little bit later, what's

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Speaker 1: your conviction trade right now? If you had a number

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Speaker 1: one conviction trade, what would it be.

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Speaker 3: Well, the most attractive asset on the board, at least

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Speaker 3: within the public opportunities set our agency mortgage backed securities.

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Speaker 3: They're trading as wide as they did during the COVID crisis.

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Speaker 3: They're wide because interest rate volatility has but high. Everyone's

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Speaker 3: concerned about the Fed selling them, the banks buying less.

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Speaker 3: But you have a high quality, liquid asset trading at

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Speaker 3: an incredibly attractive spread level. Again, a sector that we've

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Speaker 3: been consistently adding across mandates. Not the most exciting trade

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Speaker 3: in the world, but again we're at a time where

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Speaker 3: there's lots of uncertainty. It provides a steady income with

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Speaker 3: prospects for significant spread tightening if the Fed begins to

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Speaker 3: get closer to their terminal rateless cycle and we begin

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Speaker 3: to see volatility come down. So that would be our

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Speaker 3: best opportunity within the public space.

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Speaker 1: Down ovis at pimcoast c Let's not leave this four

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Speaker 1: years next time.

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Speaker 2: I can't believe it's been four years. That is going

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Speaker 2: to see you, Thank you very much, Jonathan