Stocks look pricey, the economy is showing cracks, and the Fed is an enemy to markets, says deputy chief investor of a $96 billion money manager

• Jeffrey Sherman touted bonds over stocks and flagged signs of weakness in the US economy.
• DoubleLine's deputy chief investor told Insider the Federal Reserve is an "enemy to everything."
• Sherman sees sticky inflation, and the Fed's interest-rate hikes gradually cooling the US economy.

Bonds are more enticing than stocks, the US economy is showing cracks, and the Federal Reserve is an enemy to investors, according to Jeffrey Sherman.

The deputy chief investor of DoubleLine, "Bond King" Jeffrey Gundlach's firm, which manages about $96 billion of assets, shared his outlook for markets and the economy in an interview with Insider.

The S&P 500's valuation multiple of about 19 times earnings seems "kind of rich to me," Sherman said. He warned it would be "very difficult" for the index to hit Wall Street's forecast of 12% earnings growth next year, given the Federal Reserve's ongoing efforts to cool the economy.

Sherman, a former college math-and-stats instructor who previously worked at asset manager TCW, said investors would likely have better luck with bonds. "It's hard to ignore the credit market" on a relative-value basis, he said, noting that fixed-income assets are typically much less volatile than stocks too.

The veteran money manager suggested investors "delve down in the riskier parts of credit," where yields exceed 10% in some places, while also holding risk-free Treasuries that are offering solid returns.

In addition to investment-grade bonds, which are rated BBB- or better, they might consider owning collateralized loan obligations (CLO) rated BBB and commercial mortgage-backed securities, he said.

No recession 'precipice'

Sherman rooted his view in the current economic backdrop. Consumer spending and employment have proven resilient to the Federal Reserve hiking interest rates from near zero to north of 5% since last spring in a bid to bring down inflation. While higher borrowing costs can cool demand so much that the economy shrinks, that hasn't happened to the US yet.

"I don't think we're on the precipice of a recession today," Sherman said, adding that he believes both growth and inflation have already peaked for this cycle.

However, DoubleLine's deputy CIO did highlight some areas of concern. For example, regional banks' fixed-income portfolios have slumped in value as rates climbed; they face greater risks of default among key customers like commercial real estate developers; and they remain worried about another tidal wave of deposit withdrawals like the one that took down Silicon Valley Bank and other small lenders this spring.

'Problematic' commercial property

Regional banks are the "lifeblood" of small businesses and lots of American citizens, Sherman said. "If they have to choke off credit, that throws us into recession."

Sherman also described the debt-reliant commercial real estate sector as "problematic," especially when the remote-working trend has slashed demand for office space. But he noted that some parts are doing fine, and there are still bargains to be found.

More broadly, rising delinquency rates for credit cards, auto loans, and subprime mortgages suggest parts of the economy are in trouble — even if the pain doesn't result in a full recession, Sherman said.

He underscored that the Fed's rate hikes will take time to filter through, especially as many homeowners and corporations locked in cheap rates a few years ago, so they haven't felt the squeeze of steeper borrowing costs. However, more people will start to be affected and the economy will suffer, he said.

Sherman also said he expects inflation to prove stubborn, and the Fed to cut rates later than should, as it scrambles to wrestle the pace of price growth down to 2% a year without tanking the whole economy. He warned investors against trusting the central bank to balance inflation and growth while also shoring up asset prices.

"I think they'll potentially be behind the curve when it comes to cutting rates," he said. "The Fed is not your friend - it is an enemy of everything right now."