Bear market to continue ‘into the first quarter’ of 2023: Strategist

PIMCO Portfolio Manager Erin Browne joins Yahoo Finance Live to discuss the 10-year Treasury yield, market swings, recessionary risks, consumer spending, and the health care sector.

Video Transcript

BRAD SMITH: As we head towards the last quarter of the year and the end of the year, market unease is growing over fears that the Fed might not be able to stick the landing. This as it tries to fight inflation while minimizing the chance of a recession. Some experts are bracing themselves for a bumpy ride in, but also looking to some key sectors to help smooth the way.

For more, let's bring in Erin Brown, PIMCO portfolio manager. Erin, always a pleasure to speak with you and get some of your insights. First and foremost, when you think about sticking the landing, what would that actually look like in practice?

ERIN BROWNE: Sure, so first all, with interest rates moving as much as they are, anywhere from 10 to 20 basis points each day this week, it's really hard to have stability in broader risk assets like equities and credit when you don't have stability within the core asset of markets, where all markets are priced off of, which is fixed income.

So the first thing we need to see is that we need to see rates volatility start to die down. We can't have 10 or 20 basis points move. We can't have mortgages, as mentioned earlier, up above 7%, but moving 20 basis points each day, in order to have the riskier assets classes stabilize. So that's number one.

Secondarily, we need to have more certainty with respect to the Fed path of future tightening. And typically, we see pretty volatile moves in equity markets in the last couple of months leading into the Fed sort of peak in the hiking cycle. We're not there yet. And so until we see more certainty with regards to a stabilization of the path of the Fed hiking cycle, we can't expect to see stability within equity markets.

And then third, and I think related to that last point, is we need to see a dying down of inflation. With inflation continuing to move higher and higher, the Fed has to chase that with higher interest rates. And that's a really dangerous environment for equity investors.

BRIAN SOZZI: Erin, do you think this bear market continues into next year?

ERIN BROWNE: I think it will into the first quarter of next year because the Fed is going to keep hiking. And so it's hard to have with any certainty right now what next year will bring. But I do think as we turn the quarter into the second half of next year, we'll certainly be at lower inflation levels. The Fed should be sort of at peak in terms of its hiking cycle. And I think you can start to see risk assets stabilize. But for now, over at least the next six-month horizon, I'm still concerned about equities.

JULIE HYMAN: So, Erin, what does defense look like for you right now? I mean, as we were talking about earlier, some of the sort of classically defensive sectors haven't necessarily been that defensive recently. So where do you look?

ERIN BROWNE: That's absolutely right. What you're looking for is, first, very stable balance sheets, balance sheets without a lot of leverage that aren't going to have to refinance into a higher interest rate environment. That's number one. Number two is companies that have reoccurring revenue streams that aren't looking for high nominal growth in order to drive their revenues higher, but can do well in both good times, as well as bad times.

And then thirdly, and I think importantly, is companies that you think were going to have strong profitability, strong free cash flow growth, and be able to maintain their dividends or their buyback programs. And so looking at sectors like the healthcare sector that typically screens defensively, it's underperformed this year, and I think probably wrongly so because of some of the overhang with respect to healthcare changes and the impact that that might have to the broader healthcare industry.

I think as we come in and past the midterm election, I think that you'll see healthcare do much better. Utilities also tend to do well, just because of that reoccurring revenue stream, although you do have to be somewhat cautious on the leverage in those names.

And then I think that there are starting to be select pockets within consumer that also should do well in this environment, particularly if you look at some of the big box retailers, which I think can start to really exact pricing pressure on their suppliers in order to be able to maintain their margins. And [INAUDIBLE] health is going to be really key to look for in the third quarter earnings season as an indication in terms of what stocks to buy.

BRAD SMITH: Erin, that's actually kind of what I wanted to ask you about, given yesterday's consumer confidence reading, better than expected. Where are those opportunities, especially as the consumers perhaps a little bit more confident right now than we had suspected, even with some of the forecasts that we've heard from economists going into 2023 of what a recession may look like.

ERIN BROWNE: What you're seeing from the consumer is a managing down in terms of their costs. And so they're doing so by looking at cheaper options, whether it's for food, eating more at home, shopping at stores with bigger discounts that are best in class in terms of price, like some of the big box retailers, and looking at how they think they can save in terms of their discretionary spend.

So I think that stocks that will do well in this environment are ones that are typically the trade-down stocks, the eat-at-home stocks, the big box retailers, and the names that tend to do well in sort of risk-off environments because people are really managing their costs lower and looking to save where they can. So names that are highly discretionary like travel and leisure, I think, are going to get hit. Homebuilders, I think, are going to get hit. More generic retailers will probably get hit as well. But the ones that are really focused on providing essentials are the names that I think can outperform.

BRIAN SOZZI: Thanks for reminding me, Erin, I need to trade down from my fancy steaks I've been eating to the Costco hot dog, $1.50.

ERIN BROWNE: Exactly.

BRIAN SOZZI: Erin Browne, PIMCO portfolio manager, always good to see you. We'll talk to you soon.