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Pimco's Take on Today's Market

Morningstar Rising Talent award winner Mohit Mittal discusses how the coronavirus may impact the economy in 2021.

Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

Miriam Sjoblom: Hi, I'm Miriam Sjoblom, director of fixed income Manager Research at Morningstar. I'm joined today remotely by Pimco's Mohit Mittal. Mohit is the 2020 winner of Morningstar's Rising Talent Award for Investing Excellence. He oversees Pimco's corporate credit trading desks for the U.S. and emerging markets. He also manages a variety of multisector and corporate bond strategies, including comanaging the Pimco Investment Grade Credit Fund. And starting in December 2019, he became a comanager on Pimco Total Return.

Mohit, thanks for speaking with us today. How are you?

Mohit Mittal: I'm great. Thank you, Miriam. Very nice to see you again, albeit on the screen, and I look forward to having this conversation today with you.

Sjoblom: Terrific. Before we dive into what's been happening in the bond market, some of us have been working remotely for months now, and we've had to adapt how we're doing things. How has the pandemic impacted how you and your colleagues at Pimco are doing your jobs?

Mittal: Yeah. So, I think, this has been a new unique reality. What we did in the late first week of March was we distributed our team into two different teams, one working out of the main location in Newport Beach and then another team working out of our disaster recovery site about 20 miles away from the main office, and then, some people working from home. So, over the next two weeks in March, we kind of got used to working with these multiple locations through enhanced video conferencing, through more calls over the course of the day, and then by the end of second week of March, we were quite adept and comfortable working in this new environment. So, on the whole, it was kind of a learning experience in the first one or two weeks of March. But by the end of the second week, we were quite fluent at it.

Sjoblom: Well, that's great. Yeah, we all had to get used to doing things in different ways. I want to shift and get an update on Pimco Total Return and how you and the team responded to the extremely challenging market conditions earlier this year. So, please walk us through if you could how the fund was positioned at the start of 2020 and what you and the team were focusing on when volatility spiked in February and March.

Mittal: I think 2020 has been uniquely challenging in many different ways for a lot of different people. So, for the Pimco Total Return fund, we entered March with much lower exposure to the riskier areas of credit markets and higher exposures to the more resilient and higher-quality areas like the Treasuries and the mortgages. Then, from the second week of March to the third and the fourth week of March, we saw significant changes, both in terms of economic outlook and economic growth, and also from an asset pricing point of view. Growth expectations were revised down by 10%, 15%, 20% in the three weeks of March. You saw significant weakness in oil prices. That had implications for energy-related credits. And you also saw significant amount of asset outflows out of fixed income and equity funds, which created a need for liquidity and significant opportunities across various areas.

Our focus around that time was on thinking about three things. First was with respect to the impact of COVID-19 on economic output over the next few quarters, over the next year or so; second was with respect to fiscal and the monetary policy response and the implications thereof; and then third was thinking about valuations and what that is telling us. So, we engaged extensively with our economists, with our external advisors, with our regional desk experts in thinking about each of those three things and then, at the end, kind of concluded that opportunity set has improved or enhanced, valuations have cheapened up, and while there are risks on the horizon, valuations are compensating for many of those risks. So, then we started thinking about how to take advantage of many of those opportunities, and on that front, the focus was on corporate credit markets as well as select securitized product markets.

On the corporate credit side, our focus was first thinking about kind of higher-quality investment-grade corporates in sectors like telecom, like technology, like utilities, healthcare, housing, where the direct impact from COVID-19 would be very small and manageable but the valuations because of the prevalent fear in the markets at that time had cheapened up significantly. So, that was one area of focus for us.

The second area of focus within the credit markets for us was then around sectors that were more directly tied to COVID-19, and that included leisure, lodging, travel. And on that front, we focused on senior and the secured portions of capital structures of many of the companies, but much more on a name-by-name basis, kind of cherry-picking some of those opportunities where our view based upon our credit research was that, while there will be uncertainty, while there will be significant cash flow drain in many of these companies, as senior bondholders we would still be OK in spite of the volatility.

And then, lastly, on the securitized product side, our focus was again on the AAA portions of the ABS capital structures where, because of credit enhancement, while there will be some volatility, the expected losses were very, very minimal, and because of prevalent fear, again, valuations had cheapened up to make it look attractive. So, net, kind of, quite an interesting time where we spent a lot of time in March-April doing a lot of research about the economy, about individual companies and in the end, kind of, adjusting portfolio positioning to take advantage of some of those opportunities.

Sjoblom: Thank you. That's helpful. What are Pimco's latest views on how the coronavirus will continue to impact the economy for the rest of 2020 and into 2021?

Mittal: On that front, I think the first thing for us is to have a high degree of humility with respect to thinking about or making any kind of economic forecasts. Our group CIO, Dan Ivascyn, has emphasized that point multiple times. There is unusual degree of uncertainty with respect to the path of the virus, with respect to the path of the vaccine development, and then with respect to the fiscal and monetary policy responses. With that said, in our likely base-case scenario, we think this economic recovery that started in May will likely continue for the next few quarters, albeit in an uneven fashion, meaning that it won't be a straight-line recovery, somewhat of a wavy recovery, but it will continue for the next few quarters. However, it will be important to recognize that it could be several quarters, maybe 2021 or even early 2022, before the growth reaches the levels that we saw in 2019.

On the positive side, though, we have seen an unprecedented amount of fiscal and monetary policy response, and that has really helped cause a V-shaped recovery in asset prices. So, from here on, as we think about it, we should continue to see a steady economic recovery, and that will remain supportive for asset prices. But in a scenario where either the virus situation deteriorates or the economic recovery does not come in line with those expectations, then you could see some correction in asset prices.

And then, finally, when we think about, kind of, investing opportunities in this environment, there are a lot of interesting opportunities now as well. Firstly, on the interest-rate space, we think while U.S. rates have rallied, we think relative to what U.S. Treasuries are relative to U.K., relative to Japan, relative to eurozone, there is still opportunity or at least value on relative basis relative to those economies. Mortgages also still offer a lot of value, particularly in this low-yield environment, and recognizing that the Fed QE that also includes agency mortgages is likely going to continue for some time.

And then, finally, I think with respect to credit side, we are seeing a lot of exciting opportunities. This will be a unique environment. There will be a lot of disruption. So, to an extent that credit investors have the flexibility to take advantage of many of these opportunities, then this will be a rich environment or target-rich environment on the credit side as well.

And then, also similarly, like with Europe having recently passed the European Recovery Act, we are seeing opportunities in peripheral Europe. And then, lastly, with respect to Asia, which is traditionally a savings-rich region, we're also starting to see some opportunities there as well, particularly in the sovereign, the quasi sovereign, and select credit space, which will continue to do well as the economies there heal also.

Sjoblom: You you've mentioned some areas within the corporate credit market that are looking attractive to you. But I'm just wondering to step back and get your thoughts on how attractive valuations are in the corporate credit market overall, because as you mentioned, the Fed has come in with some very firm support for that market. The investment-grade credit fund has gotten a lot of inflows, and investors have been pouring money into investment-grade corporates in recent months. Now, as things stand today, what's your view on how attractive the market is more broadly? It's obviously not the opportunity it was back in March and April, but what's your outlook for it overall?

Mittal: Yeah, you're absolutely right. I think the opportunity is not what it was in the March and April time frame. Spreads have come in significantly from the wides that we saw in March. Investment-grade spreads are about 200 basis points tighter. So, when we think about it, spreads have tightened a fair bit, but they're still wider relative to the levels that they were pre-COVID. 

Now, a lot of things have changed since February as well. First and the foremost on that front is the fundamentals of the corporate sector. Corporate sector has had to issue a lot of debt in the last four months, as you would be and our viewers here would be aware, given the massive amount of issuance, and the need for that issuance was to meet the near-term liquidity needs for many of these corporates. So, the amount of debt has gone up. At the same time, the earnings will likely be weaker third quarter and fourth quarter as well, which net means that the leverage in the corporate sector is higher than what it was pre-COVID.

Now, the question on that front is, Where does the leverage go from here? And on that front, I think, 2021, in high likelihood, the leverage should start to come down from the 2020 levels. And that will be because earnings will continue to improve and then the corporate sector will likely use some of those excess earnings to reduce some of the debt that it has taken on in 2020 because of COVID-19. So, fundamentals, while they have deteriorated, are likely to improve in 2021.

Valuations, we talked about, have tightened a fair bit but have some room to rally. And then, finally, on the technical front, I think, while the spreads and the yields have come in on a global basis relative to Europe, U.K., Japan, U.S. investment-grade yields and spreads still look more attractive relative to the options that investors have in those regions. So, on a relative basis, the demand still remains strong, which sets up for a positive technical. And then add to it the central banks' corporate credit programs, the primary and the secondary facilities, which even though have not been used to the magnitude that they were planned to be used for, they provide a nice backstop if things were to deteriorate. So, when we combine all of that, our conclusion is that, while spreads have come in significantly, there is still some potential for spreads to tighten somewhat over the next 12, 24 months, and that will offer a good return potential for the investors.

Now, I think the more important thing will be that the returns from here on will come a lot more from security credit sector selection than from the broad-based spread rally, and there, I think, investors who have access to deep credit research, able to identify those companies, will likely do better relative to others.

Sjoblom: Great. Well, you've talked a lot about where you're seeing opportunity, but I want to just hear from you: What's keeping you up at night?

Mittal: Well, I think there is plenty in this world right now to keep us all up at night. I think for me the first on that list likely is the health and the wellbeing of all of our team members across the globe, our clients, and their families. From an investment point of view, I think the thing that keeps me up at night is thinking about ways to continue to deliver strategies and products that help our clients meet their objectives in this low-yield environment.

While there is plenty to keep us awake at night, I think there's also plenty that make me super-excited to wake up every morning and come to work. And on that front, I think the first and the foremost again is the talent and the diversity of our team that has continued to, in this unique environment, work together and find ways to deliver value to our clients. And then, second on that front of excitement, would be the next couple of years would be a very target-rich environment for investment returns. I think the focus there will need to be on flexibility, thinking about flexible strategies that can take advantage of opportunities in credit across the rating spectrum, that can take advantage of opportunities in the securitized as well as interest-rate space to deliver value. So, I think there will be a lot of disruption, and what makes me excited is thinking about what opportunities that will present.

Sjoblom: Well, that's encouraging to hear. It's been a pleasure talking with you, Mohit. Thanks for sharing your latest insights with us during this challenging and unusual time in the market.