NEW YORK Feb 28 Risks of both rising stock
market volatility and inflation coupled with substantial
underpricing on both fronts make both areas compelling
investments for 2017, Pacific Investment Management Co said on
"Today's cheap implied volatility may allow for the use of
option strategies in an optimal way, either to hedge downside -
bearish - risks or to express bullish views in a cost-effective
and risk-managed fashion," Mihir Worah, Pimco's chief investment
officer of asset allocation and real return, said in remarks
posted on the firm's website. "Either way, we feel the current
price of the volatility trade is attractive."
Stock market volatility is near its lowest levels of the
past decade for fundamental and technical reasons.
Pimco, which oversees more than $1.5 trillion, said many
investors are focusing on potential outcomes of deregulation,
tax reform and fiscal stimulus under the new Trump
administration while ignoring potential outcomes of trade wars,
geopolitical flare-ups or policy errors.
"We now have some winners and some losers rather than a
market where all stocks move up or down in unison," Worah said.
"This greater dispersion among the components of an index – with
winners and losers often offsetting each other – tends to
decrease overall volatility at the index level."
In addition, the pricing of certain financial instruments
suggests investors do not believe U.S. inflation rates will rise
as quickly or as high as Pimco believes is likely.
"What we find surprising is that many of the new U.S.
administration’s suggested policies – tax cuts, infrastructure
spending, tariffs on imports, reduced immigration – would all
tend to increase inflation, yet the market for Treasury
inflation-protected securities (TIPS) seems to imply that the
Fed will not achieve its inflation target," Worah said.
The Federal Reserve has an inflation target of 2 percent.
Pimco said investors are demanding a liquidity premium for
investing in TIPS rather than Treasuries. "Investors have been
conditioned by the experience of the past several years, when
deflation was the bigger risk than rising inflation, and they
are not yet ready to price a positive inflation risk premium in
the market," he said.
Given current valuations and the increased possibility of
higher inflation, Pimco said TIPS improves a portfolio's
resilience and performance potential over a greater set of
economic outcomes. "In a world where many assets are priced for
perfection - whether overpriced or just fairly priced at best -
we feel volatility and inflation hedges are still currently
attractively priced or cheap."
(Reporting by Jennifer Ablan; Editing by Leslie Adler)