Pioneer Investments
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Pioneer's macroeconomic and investment perspectives

As the summer of 2013 drew to a close, the U.S. economy continued to advance slowly, if a bit too slow at times, while the economies in Europe and many emerging markets countries continued to deal with various issues. In the following article, Giordano Lombardo, Pioneer's Group Chief Investment Officer, discusses his views on the global macroeconomic environment and certain asset classes heading into the last few months of 2013.

Macroeconomic environment

Earlier this year, Pioneer discussed a number of factors that we believe could weigh on the global economy and the financial markets in the next few years. We argued that the world has become more unstable in the wake of the 2008 financial crisis and that the reasons for the instability – including ballooning public debt in developed countries, tireless money printing by central banks (which could possibly lead to the creation of further asset price bubbles), and increasing, and sometimes unnecessary, regulations – are not going to disappear any time soon.

Two new important macroeconomic developments have surfaced recently — the debate about the so-called tapering of the U.S. Federal Reserve's (the Fed's) loose monetary policies and the changing economic outlook in China. We believe that the most important issue facing investors is not whether the Fed's tapering of its quantitative easing policy will start sooner rather than later, but what will happen to equity markets when interest rates begin to rise, probably next year.

Pioneer's views on asset allocation

At present, we are maintaining our view that it makes sense to overweight the equity markets, particularly in developed countries. It is true that in a zero-interest-rate environment, markets are mostly driven by liquidity, leading to higher price volatility (making them appear riskier). With that said, we believe that "true risk" – in the sense of potential capital impairment – can be found more in overextended bond markets than in equities, which currently offer decent potential value over a medium- to longterm time horizon, provided that one can withstand the short-term spikes in volatility.

As for fixed-income investing, we believe that remaining flexible is a key. We believe duration and credit exposures in fixed-income portfolios will need to be dynamically adjusted in order to exploit short-term cycles in interest rates, which, from current levels, have only one direction to go: up. (Duration is a measure of a portfolio's price sensitivity to changes in interest rates.) The "mini-turmoil" in the bond markets this past June did not surprise us too much. Bond prices declined sharply nearly everywhere during that period, but we were able to lessen the adverse impact on Pioneer's portfolios by maintaining a reduced risk profile (with duration and credit-risk exposure), thanks to our flexible approach.

During the second quarter, Pioneer progressively reduced exposures to emerging markets-related asset classes, first on the bond side and then in equities and commodities. At the same time, we rebalanced the risk towards developed countries, notably to U.S. and Japanese equities. At present, we continue to prefer European to U.S. equities as we believe the latter are becoming fully valued in relation to expected corporate earnings.

For the time being, we prefer to remain underweight to emerging markets bonds, which, to us, continue to appear richly valued based mainly on their relatively low credit-risk premiums. We'd like to explore emerging markets equity opportunities on a "value" basis and try to avoid countries or sectors where fundamentals still appear priced for perfection. Naturally, the ability to invest in the right sectors, stocks, and countries will remain crucial.

Effects of rising interest rates

As for the potential impact of rising interest rates on equity markets over the next 12 to 18 months, we would point out that, based on our research, over the last 40 years inflation and unemployment factors have been responsible for roughly 70% of the Fed's tightening moves. The remaining 30% can be explained by a variety of factors, including the banking system's condition and bank reserves. We believe the effect of interest-rate tightening on the market's performance has not been dramatic during that time frame. In fact, the market experienced gains at the end of each tightening cycle

Final thoughts

We believe that equities may be able to withstand a "good" increase in interest rates (an increase based on expectations of improved economic prospects), as opposed to a "bad" increase (an increase due to rising inflation expectations). We do not see an immediate inflationary risk for the U.S., but the longer-term prospects are less certain, and we will continue to monitor the situation carefully.

The views expressed in this article are those of Pioneer Investments, and are subject to change at any time. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading intent on behalf of Pioneer.

The views expressed in this article are those of Pioneer Investments, and are subject to change at any time. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading intent on behalf of Pioneer.