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Text on screen: PIMCO Quick Takes: Navigate Inflation Concerns with a Multi-Asset Approach

Text on screen: Greg E. Sharenow, Portfolio Manager, Commodities and Real Assets

Sharenow: As we can all attest to, inflation has hit our pocketbooks, it's hit the markets, it has become a central part of the political dialogue. In 2022,

FULL PAGE GRAPHIC: TITLE – Persistent and broadening inflation led to a rapid re-pricing of Fed hikes. A line chart is shown; the subtitle for the chart reads: Higher than expected. It shows three lines. The blue line represents Core Goods. The green line represents Core Services. The black line represents the Core Consumer Price Index (CPI). All three lines showed significant increases. The biggest increases were in Core Services and Core CPI, which rose from approximately 2% in January 2019, to above 4% in mid- to late 2021, and to above 6% as of October 31, 2022.

as you can see core inflation, both goods and services, have been on the rise and have hit over 6%.

As we look to 2023 we still expect inflation to be high, although begin to moderate some.

FULL PAGE GRAPHIC: TITLE – Persistent and broadening inflation led to a rapid re-pricing of Fed hikes. A line chart is shown; the subtitle for the chart is Overshooting? It shows four lines plotted against the federal funds rate (%) on the left axis. The dark blue line represents the median federal funds rate expectations from the Federal Open Market Committee (FOMC) during its December 2021 meeting. The green line shows the FOMC’s median fed funds rate expectations during its March 2022 meeting. The red line shows the FOMC’s median fed funds rate expectations at its June 2022 meeting. The light blue line shows the FOMC’s median fed funds rate expectations at its September 2022 meeting. The chart shows the median expectations moving significantly higher, from below 1% at the FOMC’s Dec. 2021 meeting, to below 2% at its March 2022 meeting, to near 3.5% at its June 2022 meeting, to below 4.5% at its September 2022 meeting. The median expectation for the fed funds rate shows an increase to above 4.5% in 2023, trending down toward 2.5% after 2024 and beyond, based on median expectations during the September 2022 FOMC meeting.

The rise of inflation has led to significant changes in expectations for the fed in terms of the amount of hikes and to the level for which they are going to hike over the course of 2022 and 2023.

This has had a negative impact on asset pricings broadly, as we've seen with the selloff in equity markets and the retracement in fixed income markets.

The inflation backdrop has meaningful implications for investors.

FULL PAGE GRAPHIC: TITLE – Asset class sensitivities to growth and inflation surprises. The chart shows four shaded sections measured by inflation, which measures asset price movements in response to an increase or decrease in inflation, and Growth (bottom scale). The upper left corner in light blue, High inflation, Low growth, shows assets Gold and Treasury Inflation Protected Securities (TIPS). The upper right corner in green, High inflation, High growth, shows Commodities, REITs and Emerging Markets Currencies. The lower left corner in dark blue, Low inflation, Low growth, shows Core Fixed Income and Treasuries and U.S. Core Bonds. The lower right corner in red, Low inflation, High growth shows Non-Inflationary Growth, Low inflation, High growth, with Equities and High Yield.

We would expect equities to perform well in a high-growth and stable- and low-inflation environment, while fixed income the opposite in low growth. As a result, a traditional 60/40 portfolio would benefit from the diversification of owning both fixed income and equity.

The problem becomes when inflation rises and becomes less stable. In this environment, we have seen that the correlations between fixed income and equity reverse and become positive.

What asset classes could investors look to in this environment to help insulate the portfolio?

In an environment where you have high growth and high inflation, one of the best inflation-fighting assets tends to be commodities.

Now in a low-growth, high-inflation environment we would expect TIPS and gold to be an asset class that performs quite well.

Text on screen – Key Take-aways: Real assets can provide diversification across economic environments, Different types of real assets can react differently to changes in economic growth, Given macro uncertainty, investors may want to consider a multi-real asset approach

The key takeaway for investors are as follows: given the highly uncertain macro backdrop, thinking beyond a 60/40 portfolio, including real assets, can provide broader diversification across economic environments. TIPS and commodities share a linkage with inflation but can react differently to surprises in GDP and the resulting risk-on or risk-off market environment.

Investors may want to consider a multi-real asset approach that can provide broader diversification to traditional equity and bond portfolios.

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Disclosure

Past performance is not a guarantee or a reliable indicator of future results.

A word about risk: All investments contain risk and may lose value. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and low interest rate environments increase this risk. Reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Commodities contain heightened risk, including market, political, regulatory and natural conditions, and may not be appropriate for all investors. Equities may decline in value due to both real and perceived general market, economic and industry conditions. Investing in foreign-denominated and/or -domiciled securities may involve heightened risk due to currency fluctuations, and economic and political risks, which may be enhanced in emerging markets. Sovereign securities are generally backed by the issuing government. Obligations of U.S. government agencies and authorities are supported by varying degrees, but are generally not backed by the full faith of the U.S. government. Portfolios that invest in such securities are not guaranteed and will fluctuate in value. High yield, lower-rated securities involve greater risk than higher-rated securities; portfolios that invest in them may be subject to greater levels of credit and liquidity risk than portfolios that do not. REITs are subject to risk, such as poor performance by the manager, adverse changes to tax laws or failure to qualify for tax-free pass-through of income. Inflation-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. Treasury Inflation-Protected Securities (TIPS) are ILBs issued by the U.S. government. Diversification does not ensure against loss.

Statements concerning financial market trends or portfolio strategies 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 appropriate 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.

Forecasts, estimates and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. There is no guarantee that results will be achieved.

It is not possible to invest directly in an unmanaged index.

This material contains the 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.

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CMR2022-1003-2451020