Bond markets show investors concerned ‘about a recession over the next 12 months’: Strategist

Truist Chief Market Strategist Keith Lerner and Michele Schneider, Marketgauge.com Partner and Director of Trading Research & Education, join Yahoo Finance Live to discuss how markets are reacting to jobs and labor force participation data, the Fed's rate hikes, recession concerns, and stagflation indicators.

Video Transcript

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DAVE BRIGGS: There, your closing bell for the week. And here's your last numbers. Another reminder, thanks to Ines, the Dow dropping 45 points. The S&P 500 tried, it tried to have five straight up days, but couldn't quite hang on and dropping three points. Just about flat. The NASDAQ up 13 points.

Let's talk more about the markets with Keith Lerner, Truist chief market strategist, and Michele Schneider, marketgauge.com partner and director of trading research education. Nice to see you both. We'll take it. Not a terrible week, but let's start with that jobs report, Michele, and the labor force participation dropping 350,000 in the month of June, which tells you what?

MICHELE SCHNEIDER: It tells us that even though it was great to see jobs added, we still have a situation where we're going to see shortages in the labor force, which, of course, is going to affect the bottom line of so many things. But it also tells me that the market today sort of cheered the stronger report, but then thought, wait a minute, the Fed might now raise by that 75 basis points. And on the other hand, it also thought maybe inflation's not exactly going away as we thought, which is why a lot of the commodities ran up even better than what the equities did, in many cases.

RACHELLE AKUFFO: And Keith, in terms of how the markets are digesting the Fed's moves versus what we're now seeing with this jobs data, does it seem as if the markets believe the Fed is on the right track in terms of how aggressive it's going to be with the rate hikes and the tightening?

KEITH LERNER: Yeah-- well, first, great to be with you on this Friday afternoon. And at least, we've had a positive week. You know, I think it's premature to say the market believes the Fed has this right. I think the Fed has a really challenging job to do going forward. I think what you saw today is, normally, you would celebrate this, at least, headline number on employment being positive.

But as mentioned earlier, with the two-year moving up and that inversion happened, the market's still concerned about a recession over the next 12 months. And we think that risk has risen. But we did have a good week. We came into this week with sentiment very negative. We came into the quarter with only the eighth time since 1950 where we saw a quarter down 15%. So we've had an oversold bounce. It likely has a little bit to go. But we still think it's going to be pretty choppy waters over the next several months because of this tug of war between Fed policy and economic data.

DAVE BRIGGS: Yeah, the numbers are astounding, Michele. I mean, the 3.6% unemployment rate, 457,000 jobs created per month this year. And we've talked about the number, 1.9 jobs per worker open right now. Are these the makings of a recession?

MICHELE SCHNEIDER: Well, we never really like to use the word "recession." This whole time, we've been really thinking more of stagflation. And this definitely supports that case. So, as far as we were concerned, we thought the labor market would stay strong. People do have to go back to work. There certainly has been a return to work, as we saw a lot in the leisure and services areas and in the health industry areas, jobs came back. So yeah, I mean, this is really all good in terms of keeping the economy from falling apart, at least at this point.

And of course, what the Fed does will be important. But the market is really telling you exactly what's going on, which is, again-- I'm going to use that word again-- stagnation, stagflation, trading ranges that are stubborn, almost waiting to see whether the Federal Reserve goes too tight or pivots, which I don't think is going to happen. And I think all of these focuses are great-- jobs, et cetera.

But the thing you really have to focus on right now, the most important aspect of the market right now is what these raw materials do in the face of geopolitics, in the face of Mother Nature, in the face of supply chain, in the face of labor. All of these factors are really going to weigh in, I think, the heaviest. And what we can see from the Fed is they're not really sure what to do about all of that. They've even by their own admittance said that raising rates will not really help control energy and food prices going forward.

DAVE BRIGGS: And that's what I wanted to follow on. In your notes, again, you reiterate that. And you say the Fed is essentially winging it. Why do you say that? And what about today's data? Did it make their job easier or harder?

MICHELE SCHNEIDER: I think today makes that job, in some ways, easier because if you want to look at it in the sort of myopic way that the Fed is looking at it, you're going to say, great, we're not in a recession. Let's go ahead and raise, because that'll help control inflation. If you want to look at it from a broader standpoint, yes, they're going to also be raising into a stagnating economy, which could also, then, really cripple the economy and eventually put us in a recession.

There's no easy answer for the Fed. And they were so behind the ball. I mean, they didn't even use the word "inflation" until recently. And they refused to use the word "recession." And they also refused to use the word "stagflation," even though Bullard said, well, the economy is not growing, but it's not slowing. Well, duh, what does that mean?

RACHELLE AKUFFO: So then, Keith, with this choppy waters that we still do have with the Fed, we're still seeing some movement, especially this week, in the mega caps. What are you seeing in terms of the small caps? And what's the defensive play here right now?

KEITH LERNER: Yeah, well, we downgraded equities back in April. We've moved to a more defensive posture since then. I think this week, in general, you did see some reversion back to, say, growth. I think that's likely more of a short-term phenomenon, as people get concerned about the economic outlook. We still like healthcare. Healthcare made a new relative high this week. It's a cheap sector. It tends to do better in a slowing economic environment. We also like staples. That's been an overweight for some time.

And then, on the cyclical side, we just put out a note today that we see this kind of 20% pullback in energy as a buying opportunity. We've been overweight there since last February. And more specific to your question, on the small cap side, the small cap stocks are the cheapest. They've been one of the cheapest in the last 20 years. They're actually below the pandemic lows. So I think structurally over the next 5 and 10 years, that's going to be a great place to be. But right now, we have the economic cycle working against small caps. And that's why we downgraded them earlier this year to more of a neutral posture.

DAVE BRIGGS: And Keith, want to get your reaction to Michele's notion that the Fed is winging it, and can they land this plane?

KEITH LERNER: Listen, I think it's bigger than just the Fed. I mean, if you look at global central banks, we have the tightest global central bank policy tightening we've seen in the last 30 years. And we have to remember, that policy tightening works with the lag. So, yeah, the employment report was good today. But that's one of the most lagging indicators that we have. The market's looking at where are we going to be in six months from now, 12 months from now. And it's hard to make a case that we're not going to see a significant slowdown.

I will say, again, following those, like, 15% quarter downs, a year later, the market has been up every time a year later and had significant gains. But each of those times, you had a policy response. So I think we're going to need that. I just don't think near-term, we're going to see much of a pivot from the Fed, based on employment and some of the other inflation trends as well. So I think the Fed is basically boxed in at this point.

RACHELLE AKUFFO: All right, a big thank you to our market panel there. Keith Lerner of Truist and Michele Schneider from marketgauge.com. Thank you, both.