Hedge against recession with bonds while piling cash into these 3 stock sectors as markets stay flat in 2023, says Northwestern Mutual's investment chief

• In an interview with Insider, Northwestern Mutual chief investment officer Brent Schutte broke down his forecast for 2023. 
• He's expecting a mild and brief recession this year, and sees bonds as an attractive hedge. 
• He also shared three stock sectors that could offer upside during an economic downturn.

With the Federal Reserve set to battle both high inflation and a tight labor market for awhile longer, investors should position themselves for a mild, brief recession, according to Northwestern Mutual chief investment officer Brent Schutte. 

Policymakers have been working to weaken the labor market, which Schutte sees as the last shoe to drop before an official recession is declared. But thanks in part to strong consumer balance sheets, the downturn could be limited, he explained.

He sees the debt market as an important part of a resilient portfolio for the year ahead.

"The good news is that the bond market has repriced, and the bond market is a hedge against that recession," Schutte told Insider.

Bonds are also a hedge against falling equity prices, he added. Since 1926, there have been 26 times where the stock market has notched a negative year, and Schutte pointed out that bonds have been positive 21 of those times — with the five outliers being 1931, 1946, 1969, 1973, and 2022. 

The common theme in those years was that inflation was above 5% and commodity prices were high, just like they are now.

Still, he's concerned investors are leaning too hard into shorter-term bonds. Northwestern Mutual, for its part, shifted toward longer-term bonds in October after focusing on shorter-duration bonds for most of 2022.

"Investors have to think about whether they want to earn 4% or 5% on a corporate bond for 10 years, versus renting something for a couple years that will reprice," he explained. "And who knows where rates are in that time period?"

3 stock sectors for a downturn

Northwestern Mutual last year advised investors to buy into the cheaper parts of the market, and Schutte said this year's recommendation remains the same with corporate earnings set to fall and the S&P 500 poised to remain relatively flat.

"I do think any earnings decline would be brief because the recession would be brief, but those parts of the markets that are cheap are the same parts of the market that do well coming out of a recession," he explained.

Schutte said Northwestern likes international stocks, as they could see a tailwind from a falling dollar, and they're "incredibly cheap" relative to their US counterparts. 

He added that the small-cap-heavy S&P 600 looks attractive too because it has a high quality bias, and trades at roughly 12 to 13 times earnings.

Finally, he noted that Northwestern likes value stocks: "People talk about how the market overall is too expensive and therefore it must fall, so I think focusing on those cheaper parts of the market are the ones that will continue to do better in 2023."