Duration and yield curve positioning
We generally intend to be underweight duration, largely on the basis of the dearth of risk premium that is embedded across the term structure. Given the likelihood for higher volatility, we anticipate active duration management to potentially be a more significant source of alpha than in the past. We continue to believe that duration can act as a diversifier to balance the more risky components of an investment portfolio, yet we monitor potential shifts in correlations.
We lean toward positioning for a steeper yield curve, though slightly less than usual, given some evidence of weakening in the structural influences that have underpinned the steepener for decades. We see opportunities to diversify our curve positioning, including by taking exposures along yield curves in Canada, the U.K., New Zealand, and Australia.
We seek an overweight to credit, but with significant caveats. For one, we seek to gain our credit exposure from diversified sources, with cash corporates making up a smaller portion of that exposure given the narrow scope for further contraction in credit spreads.
We expect that single-name selection will likely remain a driver of returns in credit markets. We are investing in select COVID recovery themes (hotels, aerospace, and tourism), though modestly, as well as financial companies, and in sectors that we believe stand to benefit from the major transformations we have identified in our recent Secular Outlook, “Age of Transformation.” We also see opportunities in a number of structured products and asset-backed securities, including U.S. non-agency mortgage-backed securities (MBS).
PIMCO has a constructive view on global equities given the slowing yet positive earnings backdrop. (For details, please see our recent Asset Allocation Outlook.) That said, we are preparing for late-cycle dynamics, placing greater attention on security selection. We expect that large cap and high quality companies stand to outperform late in the business cycle, consistent with historical patterns. Companies with pricing power also stand to gain, in our view. The semiconductor sector has potential to outperform over the long term, benefiting from strong demand related to transformational themes discussed in our Secular Outlook, including digitalization as well as many parts of the net zero carbon effort.
On emerging market (EM) local and external debt, we are mindful of a number of risks of investing in the volatile asset class, especially amid tighter monetary policy in the U.S. We are nonetheless intrigued by a number of factors that give EM appeal in the context of a diversified portfolio and our preference for a reduced footprint in cash corporate credit instruments.
We are relatively constructive on energy prices, yet expect the price of crude oil to be constrained by increased energy output in the U.S. Natural gas prices are supported by strong exports, though increased U.S. output has us more cautious on the outlook for 2022. We are attracted to the cap-and-trade emissions market, which we expect to be strongly supported by the transformation from brown to green.