Mild recession is now ‘in the cards,’ strategist says

PIMCO Portfolio Manager Erin Browne joins Yahoo Finance Live to discuss stock portfolio positioning, the probability of a recession, industrial earnings, inflation, and the outlook for Fed policy.

Video transcript

- Welcome back to "Yahoo Finance Live" this morning, everyone. With fears of a looming recession on the minds of investors our first guest says that the question is not whether a recession is likely but rather how deep and protracted it will be. Joining us now in studio we've got Erin Browne who is the PIMCO portfolio manager. Erin, great to see you here this morning. First and foremost, we got to know, how deep, how protracted could a recession be from your estimation?

ERIN BROWNE: Sure. So I do think that both macro and the microdata points right now are leading to a view that we are likely heading into a recession if we're not already in one. Remember the first quarter GDP print was negative and wage trackers and tracking data are looking like this quarter we may also have a negative GDP print, albeit mild. And I think that that's one thing to keep in mind is that we don't have significant leverage on household balance sheets, on corporate balance sheets, that would lead us to a very deep recession.

But I do think that in the cards right now is a mild recession that will last a couple of quarters. And likely we'll come out of it sometime early next year. But it will be much more mild than what we experienced either from the global financial crisis or even from the pandemic period a couple of years ago.

- Erin, I'm looking at some of your calls here in the notes you sent over and you're suggesting short industrials even truckers. And when I see something like that, I think that maybe a recession mild isn't priced into markets here yet.

ERIN BROWNE: I think that's exactly right. When you look at earnings estimates, both for this year as well as for next year, the market's still pricing positive earnings on a year on year basis. This year it's sort of mid to high single digits and similarly priced for next year as well. So we haven't yet seen analysts really cut the earnings estimates.

In fact, since the beginning of this year, we've actually seen earnings estimates for 2022 increase by about 5%. So I think that that earnings number is certainly at risk for this year. And certain sectors like the industrials I think are even more at risk because we've seen further increases to industrial earnings estimates. And that's typically one of the cycles, or industries that is more cyclical and tends to roll over fastest when going into a recession.

- And so you mentioned next couple of quarters are going to be key here. And so over that period of time, we've got several Fed meetings that are going to be taking place too. What's their response that you've kind of factored into this estimation of how deep or protracted recession might be and what the consumer response might be to all of that.

ERIN BROWNE: Yeah. I think that's a really good question. The Fed right now is in a little bit of a pickle in the fact that they're really looking and keyed in on inflation, which continues to rise. The challenging part is that the inflation is really being driven by necessity. So it's being driven by food, inflation, and shelter.

That's not something that typically the Fed has really good ability and able to control. But yet they still have this inflation mandate that they need to fight. So I do think that the Fed will likely increase by about 150 basis points between now and year end, which will get the Fed above the neutral rate. So the Fed will be restrictive in terms of monetary policy in order to bring down inflation.

And that's going to create further pressure on financial conditions and further pressure on the consumer. So that is in part leading to this slowdown, which is intended, but also may in fact lead to a little bit of a recession, albeit a mild recession, over the next couple of quarters. And I think because of this challenge that the Fed is facing with respect to inflation, they really have their hands tied in terms of leading to an economic slowdown.

- Do you think, Erin, the Fed is back to cutting rates at some point next year?

ERIN BROWNE: I do. And the market's actually priced for about two to 2 and 1/2 cuts next year. And so I do think that that's in the cards. And you'll likely start to see in the second half of the year the Fed moving into a cutting cycle.

- And so in this near term period of time as well, for people who are trying to best position their portfolio, you know, how far out should somebody's time horizon be looking? I mean, if you're leading up to retirement, it's a little harder to say, you know, I've got a three-year time horizon. But for people who do have a longer term time horizon, what should they be focusing on?

ERIN BROWNE: Yeah, and that's a great question. I mean, I do think that opportunities like today do lead for people to be able to be a little bit patient and to start legging into portfolio positions that they're able to withstand for a long duration of time. Right now in the portfolio, I think that investors should be very defensive. Health care right now I think is very cheaply valued. I think it has very good earnings potential and it's a sector that we really like.

Consumer staples also I think is defensive and tends to do well in recessionary environments, also utilities. Sectors that I would stay away from right now and be a little bit more patient on or some of the more cyclical sectors, particularly like industrials and consumer discretionary, all which I think have further earnings downside and further price depreciation as well. But I think as we start to move, and the market starts to really price in that recession, I think then that's a time to start really being opportunistic about putting money to work in portfolio positions. But I wouldn't get scared out of the market altogether. I think you just want to be a little bit more defensively positioned within your portfolio right now.