Why it's too early to hunker down for a recession

Posted at 8:28 AM, Jun 16, 2019

(CNN) -- 1. Making sense of mixed signals: Trade wars. Inverted yield curves. And talk of a2020 recession. It's clearly an uncomfortable time for investors.

And yet US stocks have raced back to life after a horrible May. The S&P 500 finished on Friday just 2% shy of its all-time highs.

The choppy action points to the deep uncertainty in financial markets. Is this just a soft patch, like the many others that the decade-long economic expansion has survived? Or is this something more serious?

Jeffrey Sherman, deputy chief investment officer at DoubleLine Capital, is urging investors to be cautious before making any rash moves -- in either direction.

"It's too early to hunker down," Sherman told CNN Business. But it's also not the time to add large amounts of risk, he said.

Sherman's boss, famed investor Jeff Gundlach, said during a webcast on Thursday that he sees a 40% to 45% chance of a US recession within six months. DoubleLine Capital, which manages $130 billion in assets, has been migrating up the credit spectrum as the firm assesses the outlook.

The problem is that there are many mixed signals.

In the bullish camp, retail sales in the United States grew at a healthy pace in May. Shoppers splurged on electronics, appliances and of course, online. Small business optimism rebounded last month to the best level since the fall.

And the Trump administration backed away from its scary threatto impose tariffs on all goods from Mexico.

But cautionary signals have abounded. Broadcom, a leader in the bellwether chip industry, dramatically slashed its revenue guidance due to US-China trade tensions and a "broad based slowdown" in demand. China's industrial output decelerated in May to the weakest pace in 17 years.

And most alarmingly, the bond market has been acting weird.

The yield curve -- the gap between short and long-term Treasury bond yields -- has inverted, signaling that investors believe Federal Reserve policy has become too restrictive. Inversion has been a reliable recession indicator in the past.

"We don't have enough signals yet," said Sherman. "The only thing flashing red is the yield curve."

These mixed messages only make life more difficult for Fed chief Jerome Powell, who continues to be pressured by both the White House and Wall Streetto rapidly slash interest rates.

"No one envies him at this point," said Sherman.

2. High hopes for Jerome Powell: The stock market is betting on an interest rate cut by the Federal Reserve sooner rather than later. While the central bank's policy update next week Wednesday isn't expected to herald anything new, market expectations for a July rate cut are now at 87%, according to the CME FedWatch tool.

Stocks saw an epic rally last week, driven by hopes of a rate cut that would boost the US economy. It all started with Powell saying the central bank would act as appropriate to sustain the economic expansion in the United States. The Dow, the S&P 500 and the Nasdaq Composite in response all recorded their best week of the year.

All this comes only six months after the Fed took its foot of the gas in terms of rate increases. The central bank lifted rates a total of nine times, ending in December, since cutting them to ultralow levels in the aftermath of the financial crisis. Since then Powell has stressed the Fed needed to be "patient" before its next move.

That said, odds are the central bank will give investors some more indication of its intentions beforehand. And that is why next week's Fed press conference will be so closely watched.

Things could go two ways: Powell could discuss the economic data that has been undercutting expectations and repeat that the central bank intends to support the economy, thereby hinting at a rate cut. This could lead to a stock rally. Lower interest rates are good for companies, and what's good for companies is good for the stock market.

On the other hand, Powell could also stress that the Fed will need a few more data points before making a decision on interest rates, pushing a potential rate cut out to the September Fed meeting and leaving hopeful investors high and dry. Option two could see stocks heading lower.

"I don't think the Fed wants to disappoint the market again," said Brent Schutte, chief investment strategist for Northwestern Mutual Wealth Management, adding that Powell's Fed was the most market-dependent central bank he had seen.

One way or another, it looks to be a volatile week.

3. Tariff hearings begin: The United States Trade Representative's office will hold public hearings on tariffs starting Monday. Companies and leaders from industry trade groups are expected to testify.

President Donald Trump has threatened to impose tariffs on an additional $300 billion in goods imported from China — including toys, clothes, shoes, appliances and televisions. Last month, the Trump administration increased tariffs to 25% from 10% on $200 billion worth of Chinese goods.

Ahead of the hearings, more than 600 companies and industry trade associations — including Walmart, Costco, Target, Gap, Levi Strauss and Foot Locker — wrote to the White House urging Trump to remove levies on China and end the ongoing trade war.

"We know firsthand that the additional tariffs will have a significant, negative, and long-term impact on American businesses, farmers, families, and the US economy," the companies said in the letter.

4. Key test for Boeing: The Paris Air Show kicks off Monday at a particularly crucial time for Boeing, one of the world's two major commercial jet manufacturers. Typically the show is a time for Boeing and Airbus to announce orders for hundreds of aircraft, but with the 737 Max still grounded and deliveries halted, Boeing may have trouble announcing its typical number of orders this year. It hasn't announced an order for a commercial jet in more than two months.

5. Coming next week:

Monday - Paris Air Show, US Treasury foreign ownership report

Tuesday - Adobe earnings, US housing starts, US Senate hearing on tariffs

Wednesday: Fed decision and press conference, earnings from Oracle and Barnes & Noble

Thursday: US leading indicators, Bank of England rate decision, earnings from Darden, Kroger and Red Hat

Friday: US existing home sales, Markit flash US manufacturing PMI

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