‘This reminds me a lot of 1999 to 2000’: An investment chief warns that a recession is right around the corner despite overboard bullish sentiment — and shares the 3 best ways to protect your portfolio from the fallout

• Investors are ignoring the parallel between today’s market and 1999, an investment chief warns.
• The S&P 500’s August pullback may be the precursor to a painful stretch for investors.
• Here’s why a mild recession is still coming — and three ways to prepare for it now.

Stocks have fallen in August as investors become concerned after a four-month market rally, and a long-time market strategist predicts even more pain for equities and the economy.

Brent Schutte, chief investment officer for Northwestern Mutual’s wealth management division, is skeptical that this year’s gains will last. He noted that a few large tech stocks have driven much of the S&P 500’s 16% year-to-date gain, a parallel to the dot-com bubble that should give investors pause.

“This reminds me a lot of 1999 to 2000, where a small group of stocks kept pulling the market higher,” Schutte said in a recent interview with Insider. “And then they didn’t do so well for the next five, six, seven years.” They were fantastic companies, but they had already discounted all of their future prospects and were overvalued.”

Traders in 2023 are enthralled by artificial intelligence and the productivity gains it can generate for businesses. Several of this year’s top performers are linked to AI, but even if AI lives up to the hype, some fear those high-fliers will suffer the same fate as internet stocks during the 2000 tech bubble.

According to Schutte, AI is far from the only area of the market with overly optimistic sentiment. He also believes that the positive rhetoric surrounding the US economy has reached a tipping point.

“There was extreme pessimism at the start of the year, even into last year, which has now turned into optimism,” Schutte said.

“Just in the last month or so, you’ve had everybody say, ‘The coast is clear,'” Schutte continued. Inflation has decreased, and there has been no recession. As a result, there will be no recession, and the Fed may be done because CPI has decreased.’ That’s where I think it’s a little off.”

Workers’ raises raise risks for the economy

There is no greater mystery in markets than why the economy, particularly the labor market, has performed so well this year. With historically high inflation and low interest rates, strategists were almost certain that an economic downturn would occur in 2023.

Instead, investors appeared to have gotten the best of both worlds. Inflation has steadily declined toward normal levels, with no slowing of economic growth. Meanwhile, the unemployment rate continues to defy logic by remaining near multi-decade lows.

However, Schutte believes the apparent strength of the US economy may be deceptive. Employee hours are decreasing slightly, and he believes companies are delaying layoffs because they are concerned about being unable to rehire in a tight labor market.

The investment chief believes the economy will gradually lose momentum unless there is a sudden influx of workers that drives down wage growth through competition. Apart from 2020, the last three recessions were preceded by interest rate increases in response to a wage-price spiral, he noted.

“I believe a recession is on the horizon at some point,” Schutte said. “If it’s six months or nine months from now, I don’t think there’s going to be a lot of people returning to the labor market.”

“In the last three or four economic cycles, there hasn’t been a quote-unquote ‘better way’ out of the potential inflationary aspects that come with wages rising unsustainable high,” Schutte added.

Other concerns for the economy raised by Schutte include a drop in goods activity, rising credit card debt rates, and continued declines in liquidity due to a shrinking money supply and restrictive financial conditions.

3 ways to protect your portfolio now

Despite the recent market decline, investors do not appear to be concerned. Volatility, as measured by the CBOE Volatility Index (VIX), has recently increased but remains at low levels. Schutte’s caution stems primarily from his complacency and confidence.

In May, Schutte stated that he had downgraded stocks from overweight to neutral and had become bullish on bonds. In retrospect, equities still had room to run, but Schutte isn’t a Monday-morning quarterback.

“We have humility, and we don’t try to time everything,” said Schutte. “As a result, we’re reducing some of our equity risks while remaining in cheaper parts of the market and increasing our bond exposure.” So it’s a little bit of give and take on both sides.”

Schutte is currently bullish on three types of investments: fixed income, value-oriented businesses, and small- and mid-cap stocks.

Bonds are an obvious choice for safe, consistent income in a late-cycle environment, according to Schutte.

“I just want people to pump the brakes on the equity markets a little bit and not pile in as much as they have been recently,” Schutte said.

“Whether I think the recession starts tomorrow, three or six months from now,” the investment chief continued, “we are at least closer to the end of the economic cycle, and that’s where you want to behave just a little bit better.”

Schutte favors value and SMID-cap stocks because they trade at a discount to their growth and large-cap counterparts. And, while smaller companies tend to suffer more during recessions due to their sensitivity to economic swings, the market veteran believes the group is worth owning because their earnings have already been discounted.

“We’re going to ride through that cycle because I don’t believe I can time this perfectly,” Schutte explained. “And, given the valuation cushion that I have, even if there is a recession, I believe it will be brief and shallow.”