In 2009, Pimco, the world’s biggest bond investor headed by Bill Gross, coined the phrase ‘the new normal’ to describe the post-crisis backdrop.
The phrase implied that a rapid bounce-back to pre-crisis growth rates wasn’t going to happen. Pimco’s latest five-year outlook returns to – and extends – this theme. We are now in ‘the new neutral’.
Since the crisis, the private sector has worked off some of its borrowings, but governments have rapidly grown their debt piles. The risk is that the world “will be unable to grow and generate inflation at pre-crisis levels for many years to come”, even if interest rates stay at rock-bottom levels.
Europe is unlikely to muster annual growth rates of more than 1.5% or so over the next few years and the potential growth rate in America has also been reduced, cheaper energy and private-sector deleveraging notwithstanding.
With the scope for growth reduced, the level of interest rates that are neither too high nor too low for the economy (the ‘neutral level’) will be lower then before the crisis. High debts also mean that borrowers’ capacity to service or repay them is threatened by dearer money, another reason why rates will stay low.
What does this mean for assets? Returns will probably be subdued, as valuations are currently high. “With yields so low, spreads so tight, and [cyclically adjusted] price-to-earnings (p/e) ratios above historical norms, there appears to be more risk than reward on the horizon.”
The macroeconomic outlook is also uninspiring. However, with interest rates set to stay historically low, there seems little downside risk. Expect “an end to bull markets as we’ve known them, but no perceptible growling from the bears”.
Pimco expects nominal annual returns of 3% and 5% from bonds and equities respectively over the next five years.