The bond market is sending a recession signal. Here's when investors should take it seriously

Published Tue, Mar 29 20226:54 AM EDTUpdated Tue, Mar 29 20223:17 PM EDT

Patti Domm @in/patti-domm-9224884/@pattidomm

The bond market is starting to send warnings about a recession , but stock strategists say it's not yet time to load up on recession-proof stocks. They also say regardless of whether the widely watched parts of the Treasury yield curve invert, it could be quite awhile before a recession arrives and there should be concurrent signals like a bigger slowdown in economic data before investors should worry. "Generally the yield curve signals usually well in advance of the recession. The 2-year to 10-year can sometimes invert two to three years before a recession," said Jeff Kleintop, chief global investment strategist at Charles Schwab. Kleintop said investors should stick with stocks that will do well in a recovery, like energy, industrials, financials and materials. The XLE, Energy Select Sector SPDR Fund reflects the S & P energy sector, and it has been a top performing major sector fund in March, up nearly 8%. Strategists say the bond market is sending a mixed message. Probably the most widely watched yield curve - the 2-year to 10-year has been flattening, and is close to inverting like other durations have already. On Tuesday, CNBC data showed the yield curve to be nearly perfectly flat, but it had briefly inverted on other bond data systems. The 5-year to 30-year inverted Monday for the first time since 2006. But the 3-month to 10-year section of the curve is doing the exact opposite, and it has been steepening, a signal for better growth. The spread on that part of the curve was 1.9 percentage points Tuesday, compared to the 5 basis points spread between the 2-year to 10-year yields. (1 basis point equals 0.01%.) (Click here to monitor that curve in real time.) "It's certainly a very mixed signal. You have 2s to 10s looking pretty bad, and you have the 3-month to 10-year looking the steepest it's been in five years...that's the one I pay most attention to," said Kleintop. "The yield curve isn't telling you there's going to be a recession any time soon." Kleintop said he's shifted away from higher valuation, longer duration stocks, like big tech and consumer discretionary. Strategists also say the sudden moves in the bond market this month reflect the Federal Reserve's more aggressive rate-hiking policy. They also say that if the central bank were to pause its rate hiking at some point or if the war in Ukraine were to end, inverted curves could reverse. Rates have been spiking. Last week alone, the 10-year yield went from 2.14% to a high of 2.50% Friday. What to watch Patrick Palfrey, Credit Suisse equity strategist, said he watches other factors in addition to the yield curve, and they are not signaling a recession. "The 2-year is pricing in all this Fed action right now...I would say look at the confluence of variables not just the yield curve," he said. He said ISM should be a positive signal this week. Analysts also expect a strong March employment report Friday to show 460,000 jobs were added, according to Dow Jones. "The market internals don't seem really concerned about a recession, as the bond market is or as investors currently fear," said Palfrey. "If you look at stocks that are most sensitive to the economy those that favor economic expansion are the ones that see superior performance." The Materials Select Sector SPDR Fund ETF, which represents the S & P material sector, is up 7% for March so far. The Consumer Staples Select Sector Fund, which would do better in a recession, was up just 1.1% in March. Financials which do better when the yield curve was steepening lagged the S & P 500's 5.8% gain for March so far. The XLF, Financial Select Sector SPDR Fund was up 2.3% for the month. If there were a recession coming, Palfrey said he would recommend stocks in "the more defensive groups - staples, utilities, healthcare, the telecom part of communications." Palfrey listed companies that should do well in a continued expansion. Many energy names were on the list, including Exxon Mobil, Devon Energy, and ConocoPhillips. Ralph Lauren , Eastman Chemical, Mosaic and CF Industries were also on his list. Financials that should do well in a growing economy include State Street, Lincoln National , Wells Fargo and Signature Bank. Stocks that have characteristics to weather a recession include Dollar General , Clorox, Kimberly-Clark, Campbell's Soup and American Water Works. Health care companies were also on the Credit Suisse list, including Thermo Fisher Scientific , Quest Diagnostics, Bristol-Myers Squibb and Abbott Labs. Signals crossed? Strategists say despite the possibility of an inversion between the 2-year and 10-year yields, it may not be the signal it once was. That's because the Federal Reserve is holding nearly $9 trillion in Treasury and other securities on i