Market

INVESTMENT MANAGEMENT Strategy Report

August 2022

Zacks Investment Management

Born from Research, Built for Performance

IN THIS GUIDE:

Cycle Indicators are Flashing Signals. What are They? 3

Is it Time to Buy Stocks in July and August? 5
Two Attractive Sectors According to Zacks Ranks 6
Bottom Line for Investors 7
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What to Expect from This Report

The stock market has been rallying off the mid-June lows, but a cloudy economic outlook makes it
challenging to discern what lies ahead. In this month’s market strategy report, we take a look at three key
indicators that can give readers insight into the economy and markets, and break down what each indicator
is saying now.
Investors with an optimistic view – especially for the long-term – often see bear markets as buying
opportunities, particularly in sectors and companies that have come down to attractive valuations. Does
that make July and August a good time to be buying stocks? To offer a couple of ideas, we also detail two
attractive sectors we are seeing today according to Zacks Ranks.1

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Cycle Indicators are Flashing Signals. What are They?

Forecasting where the US economy and the stock market are in the cycle is difficult. Taking a look at
historically reliable indicators is a good place to start.

In the chart below, we’ve used Zacks’ Research System to pull data from Tobin’s Q, the Schiller P/E ratio, the
Equity Risk Premium, the Bank of America-Merrill Lynch US AAA Effective Bond Yield, and the LIBOR 3-month
Interest Rate:

The chart on the top shows James Tobin’s Q and Robert Shiller’s P/E ratio. The Q ratio, also known as Tobin’s
Q, equals the market value of a company divided by its asset replacement cost. This U.S. stock market
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valuation ratio is currently at 1.6. This is equivalent to stock market valuations seen from 2003 to 2007 and
from 2014 to 2019, both great periods to own stocks.

The Shiller P/E ratio for the S&P 500 index is a price-to-earnings ratio based on average inflation-adjusted
earnings from the previous 10 years. It is also known as the Cyclically Adjusted P/E Ratio (CAPE Ratio).
According to the chart, the CAPE Ratio is at 32.65x. Compare this level to the peak seen in April-June 2000
of 42.76x, versus the low seen during the Covid-19 bear market in April 2020 of 27.69x. In short, the CAPE
ratio is pretty far from dangerous peak levels, but this measure does not flash “very cheap” broad U.S. stock
market.

In the middle chart, we’ve pulled data from the Equity Risk Premium (ERP), the Bank of America-Merrill
Lynch U.S. AAA Effective Bond Yield, and the LIBOR 3-month Interest Rate. At the time of publishing, the ERP
is 4.56%. This is an ERP return equivalent to 2003 to 2007 and from 2017 to 2019, which says the amount of
underlying earnings upside to U.S. stocks is good, but not excellent. The AAA effective yield is 3.63%, which
is lower than 2003 to 2006 but equivalent to 2013 to 2019. The LIBOR 3-month interest rate is 1.47%, which is
equal to 2002 to 2004, but much lower than 2006 to 2007. In short, the spread between the ERP and effective
high-grade corporate bond yields in the US has narrowed considerably but is still roughly similar to the cycle
pattern seen from 2009 to 2019 – which comprised the longest bull market in history.

Finally, the bottom chart shows US Taxes on Corporate Income and the US Inventory Valuation Adjustment.
Corporate taxes are coming in at $469.8B. This amount of profit tax payment is similar to cycle highs seen
in 2014-15 and 2006, which implies very strong underlying US corporate profit margins. The Inventory
Valuation Adjustment is at lows not seen in earlier data, going back two decades. This is pressuring
consumer prices to stay higher, but may be due for a break.

Is It Time to Buy Stocks in July and August?

Taken together, the data is mixed but leans bullish, in our view. A forward P/E around 16x offers good price
value, assuming US corporations can continue growing earnings in the second half of the year. Current
Zacks estimates show us that this year and next year could deliver high S&P 500 single-digit EPS growth.
Those earnings outlooks can deliver the needed fundamental lift. With an upside surprise and better-than-
expected results, we could see a sustained rally looking ahead. Cyclical industrial demand is very strong, and
manufacturing has been strong for two years now. A 3.6% U.S. household unemployment rate stays across
the last four months of Bureau of Labor Statistics data.

The June Manufacturing and Services PMIs in the United States also are not flashing recessionary
conditions, at least not yet. According to the Institute for Supply Management, the June Manufacturing PMI
came in at 53%, which marked a significant deceleration from May’s 56.1% but still indicates expansion. A
similar outcome was seen in the Services sector, which posted a reading of 55.3% and continues its streak
of expansion for 25 months straight. Globally, flash PMIs show most major economies remain in expansion
territory, though all have decelerated from the spring. Readings in the low 50s – where most major
economies now reside – imply modest growth but not necessarily recession.

U.S. consumers continue to loathe economic conditions, even as household finances remain relatively
strong. At the end of Q1 2022, Federal Reserve data showed households with $18.5 trillion in cash in

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 STOCK MARKET OUTLOOK

checking accounts, savings accounts, and money market funds. Before the pandemic, that figure was
$13.3 trillion. Higher food and gas prices are weighing on people’s attitudes about the economy, with the
University of Michigan’s Consumer Sentiment Index falling to its lowest reading ever.

Just about any American who wants a job can find one, and wages have also been on the rise. In the last
year, wages have grown at a year-over-year pace of 4% each month. But it’s also true that over the same
period, inflation has exceeded 4% each month – meaning that there has not been a month with “real” year-
over-year wage growth. The same catch applies to consumer spending – Americans are doling out more for
goods and services in the economy, but they are actually consuming less than they did a year ago. Again, the
culprit here in inflation. In a more recent example, gas prices are up 60% but sales at gas stations are up 50%,
signaling that Americans are in fact driving less. There has been one exception in the spending category,
however – restaurants. Spending in June at restaurants is up 14%, but prices were only up 8%.

The negatives: Mortgage rates spiked. There is major over-priced housing on offer across the US. Any global
growth struggle can deepen and deepen. Consider the effects of the Russian war on Ukraine as a big negative
for GDP Growth in Europe. U.S. consumers may have turned more cautious, as high gasoline prices at the
pump, and sticker shock in the retail spaces, particular in Consumer Staples, are widespread.

Two Attractive Sectors According to Zacks Ranks

Zacks Ranks offer us two Attractive sectors. Again, the top one is Energy. Ongoing strength from $100+
barrels of oil, and a wild move in natural gas prices appear likely to trend higher. A major Energy/Oil stock
selloff has taken place, and underlying fundamentals are sagging a bit now, but the medium-term view still
holds. As you can see in the Zacks earnings chart below, Energy is a major contributor to positive revisions
for corporate earnings as a whole. Aggregate Energy sector earnings estimates have increased by +80.2%
since the start of the year.

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Zacks Investment Research2

A final sector we like in the current environment: Health Care. The Medical Care industry remains solid,
particularly as an aging baby boomer population creates a secular source of demand.

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Bottom Line for Investors

Cycle indicators are sending mixed signals, but the key ones we reviewed
in this strategy report seem to align on one important detail: they all align
with past bull markets. History does not determine the future, but it can help
investors assign probabilities to be used in decision-making. The signals
seem to indicate the bear market should soon give way to a bull if it hasn’t
happened already.

1
John Blank Report. 2022.
2
Zacks Investment Research. 2022. https://www.zacks.com/commentary/1955438/q2-earnings-season-off-to-a-solid-start-despite-recession-fears

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How Can Zacks Investment
Management Help?

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because, especially in volatile markets, what feels
with you to ensure disciplined investing, both in
like “the right thing to do” may actually be what
bull and bear markets.
you don’t want to do.

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D I S C L A IME R

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.

Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment
Management is an independent Registered Investment Advisory firm and acts as an investment manager for individuals
and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to
individuals.

This material is being provided for informational purposes only and nothing herein constitutes investment, legal,
accounting or tax advice, or a recommendation to buy, sell or hold a security. Do not act or rely upon the information
and advice given in this publication without seeking the services of competent and professional legal, tax, or accounting
counsel. Publication and distribution of this article is not intended to create, and the information contained herein does
not constitute, an attorney-client relationship. No recommendation or advice is being given as to whether any investment
or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies,
sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and
is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole.

Any projections, targets, or estimates in this report are forward looking statements and are based on the firm’s research,
analysis, and assumptions. Due to rapidly changing market conditions and the complexity of investment decisions,
supplemental information and other sources may be required to make informed investment decisions based on your
individual investment objectives and suitability specifications. All expressions of opinions are subject to change without
notice. Clients should seek financial advice regarding the appropriateness of investing in any security or investment
strategy discussed in this presentation.

Certain economic and market information contained herein has been obtained from published sources prepared by
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contained herein and accordingly no such persons make any representations with respect to the accuracy, completeness
or reasonableness of the information provided herein. Unless otherwise indicated, market analysis and conclusions are
based upon opinions or assumptions that Zacks Investment Management considers to be reasonable. Any investment
inherently involves a high degree of risk, beyond any specific risks discussed herein.

The S&P 500 Index is a well-known, unmanaged index of the prices of 500 large-company common stocks, mainly blue-
chip stocks, selected by Standard & Poor’s. The S&P 500 Index assumes reinvestment of dividends but does not reflect
advisory fees. The volatility of the benchmark may be materially different from the individual performance obtained by a
specific investor. An investor cannot invest directly in an index.

The Russell 1000 Growth Index is a well-known, unmanaged index of the prices of 1000 large-company growth common
stocks selected by Russell. The Russell 1000 Growth Index assumes reinvestment of dividends but does not reflect advisory
fees. An investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the
individual performance obtained by a specific investor.

Nasdaq Composite Index is the market capitalization-weighted index of over 3,300 common equities listed on the Nasdaq
stock exchange. The types of securities in the index include American depositary receipts, common stocks, real estate
investment trusts (REITs) and tracking stocks, as well as limited partnership interests. The index includes all Nasdaq-
listed stocks that are not derivatives, preferred shares, funds, exchange-traded funds (ETFs) or debenture securities. An
investor cannot invest directly in an index. The volatility of the benchmark may be materially different from the individual
performance obtained by a specific investor.

The Dow Jones Industrial Average measures the daily stock market movements of 30 U.S. publicly-traded companies listed
on the NASDAQ or the New York Stock Exchange (NYSE). The 30 publicly-owned companies are considered leaders in the
United States economy. An investor cannot directly invest in an index. The volatility of the benchmark may be materially
different from the individual performance obtained by a specific investor.

The Russell 2000 Index is a well-known, unmanaged index of the prices of 2000 small-cap company common stocks,
selected by Russell.  The Russell 2000 Index assumes reinvestment of dividends but does not reflect advisory fees.  An
investor cannot invest directly in an index.  The volatility of the benchmark may be materially different from the individual
performance obtained by a specific investor.