PIMCO’s Take on Monetary Policy, the Eurozone, and US Politics

Attendees at PIMCO’s cyclical economic forum gave a thumbs-up to the European Central Bank’s commitment to buy sovereign bonds, and a thumbs-down to American politicians.

(September 17, 2012) – Recovery will be a long and slow process for the global economy, as unconventional monetary policy helps stave off another left-tail disaster, predicts PIMCO Managing Director Saumil Parikh.

Parikh leads the investment management firm’s cyclical economic forums, and complied discussions at this month’s event into the report, titled “PIMCO Cyclical Outlook: Building Rickety Bridges to Uncertain Outcomes.”

The likelihood of depression-like left-tail risks for the global economy fell significantly when European Central Bank President Mario Draghi pledged unlimited purchases of short-dated Eurozone sovereign bonds, Perikh concludes from the discussions.

“The ECB policy action has provided the Eurozone and global economies with much-needed breathing room, and just barely at that,” he states. “The probability of a deflationary left-tail outcome emanating from the Eurozone has declined substantially in the short run, yet outright economic growth in the Eurozone will remain elusive in 2013 due to the continuation of games of chicken between policymakers across the Eurozone.”

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Speaking of playing chicken, the US’ impending fiscal cliff brought on by debt-ceiling brinksmanship drew much discussion at the forum. If the economics and investing experts in attendance lauded Mario Draghi’s “bold” move to stabilize the Euro-zone economy, they were apprehensive about policies across the pond.

“The politics of U.S. fiscal policy are about to establish an unplanned and somewhat untimely exit from unsustainably large stimulus,” Perikh writes. “The much-publicized ‘fiscal cliff’ is set to hit the U.S. economy on January 1, 2013, and, if left unchecked by new policies, will reduce US aggregate demand by an unimaginable sum of roughly $600 billion to $700 billion (about 4% of GDP).” However, PIMCO forecasts that policymakers will only allow a $200 billion to $250 billion reduction in the stimulus in 2013, resulting in a drag on the economy of roughly 1.5% of GDP, whatever the outcome of this year’s presidential election.

On the bright side, Perikh is optimistic about the US housing and real estate market, asserting the prospect of a “real recovery,” with the “added potential kicker for home price deflation turning to mild inflation over our cyclical horizon.” According to the report, PIMCO expects real residential investment to grow by 10% to 12% in 2013, directly boosting GDP by at least 0.3%. “ It is likely, as well, that real growth in housing will come with substantial positive multipliers such that the total positive impact on the US economy could be 0.5% or 0.6%,” Perikh wrote.

Institutional trading follows target price changes despite concern over the objectivity and investment value of analyst research, an academic paper asserts.

(September 17, 2012) — Changes in analysts’ price targets do, in fact, predict institutional trading, according to an academic paper by two Canadian professors.

The paper — written by Shannon Lin, a professor at Queen’s University, and Hongping Tan, a professor at the University of Waterloo — further notes that the analysis shows that the positive relation between institutional trading and target price changes is more pronounced for small firms, which generally have lower trading volume, and is limited to more active institutional investors.

In recent years, analysts have increasingly included target prices alongside earnings forecasts and stock recommendations in their research reports, conveying analysts’ assessment of the expected value of underlying stocks. The usefulness of such research is a hotly debated topic. While some investors point to the wealth of information contained in such research, “there is considerable concern over the objectivity and investment value of analyst research given the conflicts of interest problems surrounding the securities research industry,” the paper notes. “Essentially, analysts have been accused of positively biasing their opinions to attract investment banking business, to secure management access, and to generate brokerage commissions.”

In order to study whether institutional investors trade in the same direction as target price changes, the authors used a sample of analyst target price forecasts for 6,415 US firms from 1999 to 2011. The authors explain whether institutional investors trade on the information contained in target price changes and identify factors that moderate the impact of target price changes on institutional trading.

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According to Lin and Hongping, the research has important implications for market regulators. The research “fails to find a stronger reaction from institutional investors to target prices after the series of regulations introduced in the early 2000s to better discipline the security research industry,” it concludes.

Read the full paper here.