Market strategist: Russia-Ukraine risk is 'acute,' but Fed tightening will be 'more persistent'

PIMCO Portfolio Manager Erin Browne joins Yahoo Finance Live to give an outlook on the market as Russia continues its invasion of Ukraine and sanctions against Russia continue to escalate.

Video Transcript

- Well, developments in Russia and Ukraine continue to weigh on the markets as we watch about 13 minutes before the market open. Across the board futures in the major indexes down about 1%, over 1% at least for the Dow and the S&P. All of this against the backdrop of financial conditions that were already tightening as the Federal Reserve remains a story with red hot inflation still happening in the United States.

So let's get a little bit more of a breakdown on what's weighing on markets with Erin Browne, PIMCO portfolio manager. Erin, it's great to have you on the program this morning. Just kind of want to get your broad thoughts right now about what is the bigger story you think for markets given the ups and downs that we saw last week in response to the Russia and Ukraine headlines.

ERIN BROWNE: I think the acute risk certainly to markets in the very short term is residing risk from residual risk from Russia. And I think that's going to continue to weigh on risk sentiment and certainly on financial conditions which it already has over the next couple of weeks. However, if you step back and you look historically, historically these geopolitical risk off events have led to risk sell offs of about 5% to 8% and have persisted for about three months. Before they retrace to new or at least to their old sort of starting levels.

And so I think that as we move past this risk, I think the real risk for markets right now is financial conditions tightening because of the Fed. And that's certainly going to be a more persistent and long lasting risk for markets overall.

- Erin, is the next shoe to drop here, we're supposed to get commentary this week from Fed chief, Jerome Powell. Really, it would be it's his first commentary on the situation in Russia and Ukraine. Is next shoe to drop for markets him coming out and saying, we're still going to move likely on rates come that March meeting.

ERIN BROWNE: So the markets are ready retraced its expectation largely for two hikes in March. If you're even rewind two to three weeks ago, the market was concerned that the Fed would start with a 50 basis point hike in March. And now the market has moved off that and has settled back into the expectation broadly that we're probably going to see only 25 basis points of interest rate hike in March.

The question is going to be after the March hike what the Fed pace of removal of accommodation is. I think that if the market continues to believe that the Fed will be fairly regimented in its approach with 25 basis points per meeting and doesn't accelerate the pace beyond that, I think that the markets already digested that so I don't think that's going to be the next shoe to drop. I think that's already embedded in market expectations.

But given the risk that we have now around Russia, given the fact that the Fed is starting to tighten and eventually will announce quantitative tightening with the stop, the eventual sort of stopping of reinvestments, I do think that the market right now is really keyed into growth and the impact that all of this financial condition tightening will have to growth and ultimately to markets.

- Erin, did you see any impact of that on earnings in the fourth quarter of last year? I mean, the Fed hasn't started tightening yet but we've already seen longer term borrowing costs going up on the expectation that the Fed would start hiking. Have you seen margins get compressed or anything in corporate earnings that tell you kind of now is the time to start thinking about maybe even rebalancing your portfolio?

ERIN BROWNE: It's a really interesting question because through the fourth quarter of last year we saw by and large companies being able to continue to drive margins higher or at least maintain margins. And you haven't seen significant cost pressures eating into margins as of yet for the market. However, what we did here in fourth quarter earnings guidance is that it's likely to get tougher as we start to move through 2022.

And you saw real differentiation between those companies that really gear or catered to the lower end consumer versus those that are more geared towards the higher end consumer or to businesses. The lower end consumer because of the end of the child tax credit and because of the end of fiscal stimulus, is now starting to really take pains in terms of higher cost pressures. And I think as we continue to move through 2022, what we heard from corporates is that they expect that it's going to get harder and harder to be able to pass on those higher costs to the lower end consumer.

And I think you're going to start to see this really play out as we move through 2022 in terms of those companies that are able to drive margins higher and be able to pass through those costs and those that aren't. And so that I think is going to lead to real differentiation in the underlying stocks.

- Over the past week or so, Erin, what changes, if any, have you made to your portfolios?

ERIN BROWNE: So we have taken down risks slightly and that's really just to take some chips off the table, to be patient and wait for better entry points. I do think that the market is starting to look more attractive. We've seen an 8% sell off, I think as the market opens today will be in excess of 9% sell off year to date. You have seen some stocks getting discounted pretty heavily in excess of that market average. And so I think that there are attractive opportunities but I want to be patient, wait for the dust to settle, wait for more clarity with regards to Russia and then we'll start to nibble back into the market.

- All right, Erin Browne, PIMCO portfolio manager. Thanks so much for breaking all this down for us. Have a great week.

ERIN BROWNE: Thank you.