History suggests that if the bond market is correct about a recession coming, the stock market will start to send some signals as well. Consequently, investors are beginning to make plans should the economy contract over the next year or two. One of fixed income's most notorious signs that danger is coming started to flash last week, when the yield on the 2-year Treasury rose above that of the 10-year note. That so-called inversion has been present for virtually every recession since World War II, though inversions have happened without accompanying periods of negative growth. "Now the clock starts ticking," Richard Bernstein, CEO of Richard Bernstein Advisors, told CNBC's " Power Lunch " in a Monday interview. "But the clock historically has been, I don't know, a year, year and a half until you get a bear market and a recession. So what you have to start doing now is looking for corroborating evidence." Top Wall Street investors like Bernstein say there are stocks to watch that will provide clues about what's ahead. For some observers, the signal will come from big-box retailers. Others are watching the major delivery companies. Franchise restaurants and home builders also are considered solid proxies for future growth. Bernstein said investors concerned that the economy is slowing should start pulling risk off the table, albeit slowly, and look for "late-cycle" names — the classic plays in the consumer staples, health care and utilities sectors that fare well as expansions lose steam and the economy transitions to a period of lower or negative growth. Indeed, some of the major names coming up in recent discussions about a looming recession are big-box retailers such as Walmart and Costco . CNBC "Mad Money" host Jim Cramer recently brought up Walmart's recent rise — up 3.5% in the past five days as the yield curve inverted — as a possible recession warning sign. The strategy holds that consumers will start to switch their spending habits from higher-end stores to other mid- and lower-market brands to save money. In a note late last week, Bank of America chief investment strategist Michael Hartnett picked out recent gains in Costco (a "retailer to Main Street") and declines in homebuilder Toll Brothers ("housebuilder to Wall Street") as a "recession/risk-off signal." Recession doubters To be sure, not all the economic news is bad, and some investors are looking at stocks that are contradicting the recession narrative. National Securities chief market strategist Art Hogan views the major delivery companies, such as UPS and FedEx , as being better indicators of where the economy is headed. Those stocks have faltered in the days since the yield curve inverted. But Hogan thinks they'll ultimately indicate that the economy will make it through the recession scare. "I would rather look at UPS or FedEx than Walmart or Costco. Those are really consumer staples to me," he said. "I would rather look at the guys really moving online commerce around." Hogan thinks those stocks will tell the story of an economy in which financial conditions are still relatively loose and consumer demand is strong. "Are we going to have above-mean GDP growth this year? That's a question mark," he said. "Are we going to have a couple quarters of no economic growth? I just don't think that's in the cards for the next 12 months." In fact, a different part of the yield curve, between the 3-month note and 10-year bond, is not showing any recession signals. The spread between the two was about 1.88 percentage points in Tuesday trading, which would indicate a single-digit chance of a recession. That spread is the one watched closely by the New York Federal Reserve, which tracks the relationship on its site . As of the end of March, the indicated chance of recession was just 5.5%, according to the New York Fed. Taking the long view It may well be the case that the economy skirts a recession for the next year. But indicators like the yield curve are about longer-term prospects, and that's what has some people on Wall Street scared. Analysts at Baird are telling clients to keep an eye on companies such as McDonald's and Yum Brands as bellwethers for changing consumer appetites. "We still believe some exposure to the sector is warranted when considering that many restaurant business models contain attributes that should be considered attractive in the current market backdrop, including relatively stable top-line outlook (with restaurants seen as less discretionary than other consumer sectors) and fairly durable income streams (particularly for highly franchised systems)," the firm's analysts said in a note this week. They did caution using "a selective approach" within the group. They noted, however, that "highly franchised businesses" could react positively to inflation and the accompanying higher interest rates, which some economists think will torpedo growth ahead. Deutsche Bank on Tuesday became the first Wall Street bank to predict inflation-induced recession , saying it expects the downturn to begin in late 2023 and last into 2024. Craig Kennison, senior research analyst at Baird, is watching stocks that tend to underperform heading into recession than outperform later. Among those, he told CNBC, are marine-recreation product maker Brunswick and recreational vehicle giant Winnebago . "We like companies that are gaining share with a strong balance sheet and active buyback program. It could be a difficult six months," he said. "Our trading signal would suggest you can afford to be patient. Build a shopping list today and then go ahead and buy as panic sets in."
Shopping carts are lined up in front of a Costco store on February 25, 2021 in Inglewood, California.
Mario Tama | Getty Images
History suggests that if the bond market is correct about a recession coming, the stock market will start to send some signals as well.
Consequently, investors are beginning to make plans should the economy contract over the next year or two.