Stock Market Outlook 11 Adjusted for seasonal factors, the Purchasing Managers’ Index™ (PMI™) – a composite indicator designed to provide a single-figure snapshot of operating conditions in the manufacturing economy – dipped to 49.2 in May, down from 49.4 in April, and below the neutral 50.0 value for the fifteenth successive month. That said, the PMI reading remained consistent with only a marginal deterioration in the health of the sector overall. Manufacturing PMIs in China averaged 49.36 from 2011 until 2016, reaching an all time high of 52.30 in January of 2013 and a record low of 47.20 in September of 2015. In another Asian space, Modi’s India stays on track for +7.5% annual GDP growth. For Brazil, GDP data show a deeper -6% annual recession. My calls? Brazil and Russia are well past technical share bottoms. Fundamentals have turned. One subscriber in Brazil called it a deformed ball. You don’t know how it is going to bounce. Note: 68% of S&P500 revenues come from North America, 11% from Europe, and 10% from Asia. DJIA Similar to the S&P500, the Dow move can get to a new high this year. NASDAQ Stay positive long-term on IT. Info Tech is in the top half of the Zacks Industry Ranks. However, IT cap-ex and consumer spending seems weak in the first half. Q2 looks for -7.2% from the sector. Q1-16 IT sector EPS growth looked poor at -6.0%. Q4-15 was +3.7%. Q3-15 was +4.7. Q2-15 was +3.7%. Q1-15 was +2.7%. Across 2016, IT tallies +2.6% EPS growth and +3.1% revenue growth. Zacks Rank #1 IT remains worth buying and holding long-term. AAPL is a disproportionate part of the QQQs Shares briefly broke below $100 a share in August 2015 in the Algo-electronic assisted panic, and re-tested that August low at $92 in early 2016. Share are $93 after iPhone sales dipped. The S&P500 is rising without AAPL, thanks to the turn in Energy and Materials. Bottom-up S&P 500 Earnings from Zacks Research System (ZRS) Bottoms-up projections say earnings were -1.1% in 2015. They could be +0.8% in 2016 and +13.4% in 2017. S&P 500 earnings were up +4.8% in 2014. Top-down S&P 500 Earnings from ZRS The 2016 top-down estimates look a bit more optimistic. Top-down forecasts see less than +4.0% annual earnings growth for 2016 and +9.5% in 2017. Russell 2000 Russell 2000 stocks lead as markets go “Risk-on”. Fast-growing small U.S. companies beat consensus more easily. A 2016 “risk-on” rally remains my call, after two years of poor performance. The backdrop: Always be mindful of illiquid small cap shorting. In ‘Risk-off” trading, shorts can cut many small cap shares down by -50%. Fed Funds A first Fed rate hike happened in Dec. 2015. Odds are data dependent across 2016. It’s not a pre-set course, but 2 more (June/July and Dec?) look likely. A sound U.S. payroll outlook helps. Global growth and S&P500 EPS upgrades would help more. The FOMC holds off if stocks get hit hard; the USD gets too strong; and U.S. exports fall too much.

Stock marketoutlook 0616 from Charles Graham 

 Stock marketoutlook 0616

1. 1. Stock Market Outlook Zacks INVESTMENT MANAGEMENT Forecasts ofFUTURE Asset Class Returns John Blank, Ph.D. June/July 2016
2. 2. ZACKS INVESTMENT MANAGEMENT 2 Table of Contents Commentary 1. Zacks June View on EquityMARKETS…..………….....................…….…3 2. U.S. Macro Outlook from San Fran Fed.………………………………….. 5 3. Zacks Forecasts at a Glance………………………..……………….…..…7 Top-Down Zacks Rank 4. ZRS Chart of the Month..…………………………………………...........14 5. Zacks Rank S&P 500 Sector Picks.………..…….....………….................15 6. Zacks Rank June Industry Tables……..…..............….….….....…........16 Asset Allocation 7. June Buy-Side and Sell-Side: Consensus at a Glance…….……........20
3. 3. Stock Market Outlook 3 Commentary 1. Zacks June View on Equity Markets U.S. Markets One of the big bull/bear issues for the S&P500 seems to be this. Big multi-nationals score ever-higher profitability, lifting EPS… and struggle to find revenue growth. In light of that, I did some digging into the issue this month. What I found interesting is in 2 charts below. The first chart shows the Gross Margin of the S&P500 over the last 20 years. What you can see is that 45 to 51% has been the range. This cycle has seen a 49% gross margin. In short, the U.S. Gross Margin for its big, big companies is basically trapped in a range. However, things are vastly different when you take a look at Net Margin on the S&P500. This has been going up for the last 20 years. It was 8% in 1996. It is a whopping 13% now. That means this: Big companies in the S&P500 are driving up profitability in ‘above the line’ categories like Sales, General & Administrative and in cutting interest rate costs or texes. This points the finger at a few underlyingSOURCES of Net Margin profitability for big S&P500 companies. (1) The Internet’s growth meant less SG&A. (2) More cheap goods imports from abroad meant relatively less SG&A. (3) A constant fall in nominal interest rates over the last 20 years meant less financing cost. (4) Mergers and acquisitions often took out SG&A to drive cost benefits. (5) Larger market sizes led to scale benefits. (6) Lower tax rates. This rise in Net Margin on the S&P500 is finding its way back to shareholders in the form of rising buybacks. However, the combined elements under this rising Net Margin phenomenon hold back revenue growth. Extra profit doesn’t find its way directly into incomes of U.S. workers, broadly speaking. It just flows to shareholders, who then complain about the lack of revenue growth.
4. 4. ZACKS INVESTMENT MANAGEMENT 4 Global Markets Two regions of the world, Europe and Asia have two high-income behemoths at their macroeconomic center of gravity. In Europe, it is Germany, with a GDP per capita of $42K. In Asia, it is Japan at $36K. The next nearest country in each region is about -25% below that in terms of income per capita. For example, Italy is at $31K. South Korea is at $27K. Below that ‘next nearest’ level, the 2 regions are vastly different. In Europe the weak sister withPROBLEMS is tiny Greece. It is 45% of Germany’s per capita income at $19K a year. In Asia, Japan has to contend with an absolutely massive population of Chinese willing to work for an average of $9K a year in income, which is equally: $750 a month, or $187.50 a week, or $37.50 a day, or $4.68 an hour. The Vietnamese work for less than $3K a year on average, or $193 a month, or roughly $50 a week. GDP per Capita, currentPRICES (IMF.org) Europe 2017 GDP per Capita % Diff from Germany or Japan Germany $42,269 Italy $30,995 73% Spain $27,920 66% Greece $18,873 45% Asia 2017 GDP per Capita % Diff from Germany or Japan Japan $35,793 South Korea $27,023 75% China $8,833 25% Vietnam $2,327 7% What’s my point in bringing this up? Germany and Japan both have very low unemployment rates. Yet, Germany sees solid GDP growth. Japan does not. Germany is yoked into a euro currency. The euro FX rate going from 1.35 to 1.10 is a -25% move. This is roughly in line with the differences between Germany’s effective income per capita and Italy. That means the euro currency can do some competitiveness work for Europe as a whole, as it gets cheaper and cheaper. What has the Yen moving from 125 to 110 done to that region’s competiveness? That is a -15% weakness in favor of Japan over nearby Asian rivals. This may help, in principle, with export competitiveness with the likes of a high-income comparable like South Korea. It is nowhere near enough to deal with Mainland China. It is no help at all with Vietnam. That explains a great deal. The ability to get Japanese manufacturing moving again is going to be so much harder than getting Germany moving. The regions aren’t apples to apples. At all! When we ask how the global economy is going to turn up, we need to realize income disparities (and therefore wage rates) inside these two regions are vastly different. Exchange rate moves can’t end the struggle of Japan with weak growth --and wage driven price deflation—anytime in the next few decades. In Europe, the euro move made a real difference. The yen FX rate is just not going to make a dent in Japan’s huge regional competivenessPROBLEM. This may go a ways in explaining the weird behavior of the yen in 2016. It matter little if the yen goes up or down to Asia, outside of South Korea.
5. 5. Stock Market Outlook 5 2. U.S. Macro Outlook-- San Francisco Fed “Fed Views” Rob Valletta, vice president at the Federal Reserve Bank of San Francisco, stated his views on the current economy and the outlook as of May 12, 2016. GDP and the Fed-- The U.S. Bureau of Economic Analysis (BEA) reported real GDP grew at a sluggish 0.8% annual pace in the first quarter of 2016. Weak measured first-quarter growth has been a consistent pattern in recent years, and research conducted at the San Francisco Fed suggests regular seasonal fluctuations are not fully captured by the BEA’s current adjustment methodology. Using a more complete seasonal adjustment suggests that growth exceeded 2% in the first quarter and, relative to four quarters earlier, GDP growth remains in line with last year’s pace. We expect this pace to continue through 2016, spurred by further growth in household income and spending. Increasingly supportive financial conditions have bolstered the growth outlook. Interest rates have declined this year across a broad spectrum of maturities and risk classes. In addition, the U.S. dollar has retraced some of its earlier appreciation, and domestic stock market indexes are up more than 10% from their mid-February lows. Following a quarter-point increase in December, the Federal Open Market Committee (FOMC) has left the federal funds rate target unchanged. The accommodative stance of monetary policy aims to support further improvement in labor market conditions and a return to 2% inflation. The FOMC has emphasized that future increases in the funds rate target will be gradual, with the timing dependent on labor market data, the inflation outlook, and readings on financial and international conditions. Over the past few quarters, inflation has moved up noticeably, reflecting in part the expected waning of disinflationary effects from the prior dollar appreciation and energy price declines. We anticipate that inflation will continue to firm, with the overall and core measures converging on the FOMC’s 2% target over the next two years. Jobs-- Job growth has stayed strong, with the six-month average gains remaining above 200,000. Though the April reading of 160,000 new jobs represents a slowdown from prior months, it is well above the level needed to support further improvement in overall labor market conditions, estimated to be around 100,000 or fewer new jobs per month. Unemployment has been largely unchanged this year, and April’s unemployment rate of 5% equals our estimate of its natural or normal rate. This flat rate of unemployment reflects an ongoing pickup in labor force participation, consistent with improving labor market conditions. As the labor market expansion continues, we expect the unemployment rate to fall a bit further and then head back up toward the natural rate beginning in mid-2017. In addition to strong job growth and the low rate of unemployment, other indicators of strength in the labor market include ample job vacancies and high rates of voluntary quitting by workers who seek improving job opportunities.
6. 6. ZACKS INVESTMENT MANAGEMENT 6 By contrast, the elevated rate of long-term unemployment suggests labor market conditions may not have fully returned to normal. Long-term unemployment, defined as active job search for longer than six consecutive months, still remains above the historical highs observed prior to the Great Recession. Movement in long-term unemployment over the business cycle largely reflects changes in job-finding rates. During and immediately after the Great Recession, finding a job was difficult. As the economy improved and job opportunities increased, job-finding rates recovered, especially for those unemployed for less than six months. This in turn reduced the fraction of those who subsequently become long-term unemployed. However, job-finding rates for the long-term unemployed remain somewhat low as a result of long-term changes in the composition and behavior of the labor force. Older workers are less likely to lose jobs than younger workers but are more likely to undertake prolonged searches when job loss occurs. As the population ages, older job seekers have comprised a rising share of the total unemployment pool, which mechanically increases long-term unemployment. Rising labor force attachment for women during the 1980s and 1990s has also contributed to higher long-term unemployment. Fewer labor force transitions by women has lengthened reported unemployment and contributed to a secular increase in overall long-term unemployment. These higher rates of long-term unemployment among both older workers and women generally reflect more dedication to sustained job searches, rather than a lack of education or other skills that would typically limit job prospects. Hence, the currently high long-term unemployment does not appear to signal broad labor market weakness.     
7. 7. Stock Market Outlook 7 3. Zacks Forecasts at a Glance Summer is here. In spring, the lousiest start for stocks in a New Year on record turned dramatically. The S&P500 trades in a tight mid-2016 range near its all-time high seen in summer 2015. This key index is 2100 as I write. Chinese shares opened the years trading on a down note. Their manufacturing PMIs limped into the New Year. China PMIs stabilized in early April. May saw more stabilization. Europe has stepped up money stimulus. Japan’s yen (oddly) strengthened under negative rates. In light of external concerns, the U.S. backed down on multiple rate hikes. This keeps the U.S. 10-year very, very low, adding a rate stimulus to the mix in the first half of 2016. The second half should see 2 hikes of 25 bps from the Fed. There are signs aplenty. The 18-month long commodity price collapse turned. Hope exists a positive tone lasts after summer 2016. Last year, the stock market offered no returns. In 2014, U.S. stocks rose +12% on a last U.S. QE pop. 2013 saw +32%. What compels U.S. optimism on 2016? U.S. jobs and better wages build confidence. Stock wealth supports spending. A 4+ month long rally from mid-Feb lows climbed a wall of worry. Demographics and policy build Health Care. U.S. house buying stays strong. What’s alive for pessimists? Valuations are rich. There is major worry about Bank’s health, given the super low rate environ- ment dragging on. An earnings recession keeps on going. 5 straight negative quarters is forecast. In Jan-16, top-down analysts had an S&P500 YE target of 2,193. This was lowered in February. That showed myopic ambu- lance chasing, in my opinion. “Sell in May” was just a mantra. Markets can look much further ahead, as global risks fall back. Early concern for Wall Street strategists on 2016 was if divergent central-bank policies — Fed tightening and ECB easing — boosted the U.S. dollar and further pressured earnings of U.S. companies doing business abroad. Strategists also looked for heightened volatility and uncertainty during this Presidential election year. Is it time to buy the U.S. in early June? An oil and materials price bottom is fully in. That is bullish risk. The S&P500 can finish 2016 above 2200, which is a +5% return. Another big positive: A U.S. 5.0% unemployment rate adds consumer momentum via pending wage pressure. This builds incomes. U.S. shares have recovered. Watch for bullish S&P500 breaks of 2,100 in June or later. Before the Aug. 2015 sell-off, the S&P500 traded at 16.6x forward earnings vs. a 10-year average of 14.1x. The Feb index traded at 15.2. The June 2016 index trades at 16.7x forward earnings. Bearishly, we trade a bit above valuation levels of August 2015. Zacks strategists still call an S&P500 at 2,200 to 2,300 by yearend, given a 15% chance of U.S. recession (including me). • Bulls see modest cyclical upside. China rate cuts sink in. Asian and Europe share momentum builds, as non-US indexes offer attractive valuations. Non-US currencies, among them the euro, already reset global competiveness. Although lately, a 1.12 on the euro FX cross is reversing some of that.
8. 8. ZACKS INVESTMENT MANAGEMENT 8 • Bears point to (-10% to -20% downside) full U.S. valuations and more Fed rate hikes. They also focus on tepid non-U.S. growth and non-U.S. recessions. • Range-bound sages note listless global growth. A record commodity & oil price collapse could re-emerge. 10-year U.S. rates are held down, as European QE heads up and Japan’s negative rates force buying of the U.S. 10-year trea- sury. What of U.S. GDP growth? It should be the top-of-mind fundamental in investor’s minds. On June 1st , GDPNow at the Atlanta Fed had a +2.5% reading for Q2-16. Final Q1-16 came in at +0.8%. Q4-15 GDP came in at +1.0%. Q3-15 came in at +2.1%. Q2-15 GDP grew +3.9%. For reference, winter Q1-15 was +0.6%. Winter Q1-14 GDP was -2.1%. “Muddle Through” +2.2% to +2.5% U.S. GDP growth is our call on 2016. Top-Down S&P 500 End-Of-Year 2016 Target We are at 2100 on the S&P 500 in early JUNE. The S&P 500 breaks thru its high at 2135. Weak Q1-16 U.S earnings can only be ignored via a summer 2016 look ahead to 2017. Earnings and revenue growth are not expected to return until 2H 2016. Yes, the U.S. remains in expansion. Recent monthly labor market evidence was NOT conclusive however. The U.S. created just +38K new jobs in May. On top of that, hiring in the prior two months turned out to be weaker than originally reported. The number of new jobs was the smallest the economy created since the fall of 2010. Consensus had pegged an increase of +155K nonfarm jobs. The government said +123K new jobs were created in April instead of +160K. March’s gain lowered to +186K from +208K. Feb. added +245K jobs. Jan. added a weaker winter seasonal +168K. Late last year, Dec-15 added a strong +262K U.S. jobs and Nov-15 added +280K job adds. Oct-15’s revised +307K were the biggest of 2015. In a twist going the other way, the U.S. unemployment fell to 4.7% rate in May after having ticked back up to 5.0% in March 2016. That’s frictional unemployment. Muddle Through U.S. growth and strong U.S. labor markets say, “Don’t worry”. +1.0% in GDP growth over a year (we saw +0.8 in Q1) is usually when recession selling gets triggered. Solid jobs tell us rising U.S. stock indexes remain the base case in 2016. June showed May’s new sector leaders stuck. In May, up from the bottom came the Industrials and Materials sectors. This is worth investigating. Added to that, the Consumer Staples and Discretionary sectors look hot in early June. Health Care remains a solid area. Energy, sensing a WTI and Brent oil price stall, stayed at Market Weight. In early June, a “risk on” rally has taken the Russell 2000 from 1000 in early Feb to 1,150. In Dec. 2015, the small cap RUT traded at 1,200, implying another +5% more “risk-on” recovery in values here. In 1H-15, the RUT index rallied from 1,200 to 1,300. The swift Aug. 2015 sell-off pushed it down. “Risk-on” rallies usually show small cap and international stock indexes move together. My call: keeping buying international and the RUT on cheap valuations and restored EPS growth. Outside the U.S., the euro is 1.12 as I write. A 1.08 euro/USD rate came into play late last year. The rate was 1.13 last fall. Euro parity may not happen, as earlier consensus projected. European share indexes do appear out of a bear market. They have gotten a weak bid of late. Does a Fed Taper tantrum aka 2013 hit in 2016? That’s very unlikely. We can continue to climb the wall of worry outside the U.S.
9. 9. Stock Market Outlook 9 Risks –on China— stabilized in May. Look further back, a sudden depreciation of the renminbi in August 2015 sent profiteers out of China to protect gains before a second renminbi haircut hits in 2016. Watch out for another haircut! Turn any P/E ratio on its head to attain a stock indexes’ actual earnings yield. Divide $119 in projected earnings for 2016 by an S&P 500 trading at 2080. That begets a 5.7% earnings yield. After a +32% rally in 2013, and +12% returns in 2014, evidence does still exist on share index undervaluation. Zacks in-House outlook: U.S. indexes trade a 2H-2016 and 1H-2017 landscape. Early 2016 EPS outlooks drive “fair value” computations less and less now. 2017 comes into view. Record low long-term bond rates, kept down by a dovish Fed Chair, who is also boxed in by BoJ negative rates and Draghi’s monthly bond buys, keeps a bid on for risk. “Raging” bulls at Zacks use $135 in earnings for 2017 (and a 16 P/E ratio) and say the S&P500 index at 2160 is fair value by mid-2016. Our pessimists say the S&P 500 index at 2080-2100 shows up as resistance --given 2016 EPS growth looks disappointing. Our optimists say the probability of a U.S. recession looks remote. Getting a refreshed U.S. valuation expansion in train offers more upside on U.S. stocks. If 2H-2016 and 2017 earnings forecasts move up on this oil and materials upturn, and rates stay at record lows, the bull runs. What if markets get the 10-year risk-free rate above a 3% rate, even 2.5%? Relative bond/stock valuation gets tight. Watch for that! To conclude, stocks saw a sharp New Year’s correction. That started 2016 off with a -12% returns hole to fill. A positive outlook waited on an oil price bottom. $26 a barrel for WTI oil low looks like an oil price bottom for 2016. Stocks are back to the top of a range. S&P 500 Consensus sees +0.8% in EPS growth for 2016 and a hockey stick +13.4% for 2017. In 2015, the S&P500 saw -1.1%. In 2014, it saw +4.8%. Consensus uses +1.7% for 2016 and +5.9% for 2017 as fresh revenue growth comps. The S&P500 EPS growth decline should hit bottom in Q1-16. Q2-16 consensus looks for a -4.8% decline. Q1-16 saw a -6.7% EPS decline. For Q4-15, it was -3.3%. Q3-15 EPS was -1.3%. Q2-15 EPS was -1.3%. Q1-15 EPS was +0.8%. Q4-14 EPS was +3.7%. Q3-14 was +8.0%. This shows 4 consecutive quarters of negative EPS growth, a time series last seen in 2008-09. Q2 is likely to make it 5 negative quarters. At -1.1% EPS growth, 2015 was an S&P500 EPS year to forget. A big -60% EPS drag from the Energy sector hurt 2015 the most. -7.3% for Materials and -1.0% for Industrials was pathetic. Here’s what helped-- Telcos (+31.1%), Health Care (+13.5%), Consumer Discretionary (+11.0%), Financials (+9.2%), and Info Tech (+3.7%). Utilities (-15.9%) were at the back. A variety of S&P500 sectors lead the latest annual 2016 EPS outlook – Energy (Now -66%) looks awful and too pessimistic. Materials (-1.1%) EPS looks much better. Domestic cyclical sectors like Consumer Discretionary (+11.4%) and Health Care (+7.1%) lead. Utilities (4.7%), Financials (+2.6%), Consumer Staples (+3.7%), and Info Tech (+2.6%) are middle of the road. Industrials (-0.3%) remain at the back, also likely overly pessimistic. Telcos (-6.3%) are last, where deep defensives sit. Investors – Stay optimistic about cyclical S&P500 2016 EPS sectors. However, estimates for both 2015 EPS and revenue growth looked weak -- due to the oil price collapse, and negative exports effects from a strong U.S. dollar. 2016 EPS revives via spending consumers with stable jobs. They benefit from low gas prices too. Negative oil supply effects are concentrated and quick. Demand? Diffuse and reduced by savings.
10. 10. ZACKS INVESTMENT MANAGEMENT 10 At 50.7 in May, 50.8 in April, 51.5 in March, and 51.3 in Feb., the U.S. manufacturing PMI barely stays in modest expansion. The recent downtrend is not heartening. 52.4 was the January read, up slightly on December’s 38-month low of 51.2. May Markit PMI survey respondents noted subdued client demand and heightened economic uncertainty had resulted in challenging trading conditions. Manufacturing payroll numbers nonetheless picked up slightly in May, which firms linked to new product launches and sustained optimism regarding the longer-term business outlook. Manufacturing PMIs in the U.S. averaged 53.95 from 2012 to 2016, reaching an all-time high of 57.90 in Aug. 2014 and a low of 51 in Nov. 2012. How about a non-U.S. perspective? S&P500 companies get 32% of revenues abroad. The J.P.Morgan Global Manufacturing PMI posted a 50 in May and a 50.1 in April. The global manufacturing sector maintained its lethargic start to 2016. At 50.0 in May, the J.P.Morgan Global Manufacturing PMI™ – a composite index produced by J.P.Morgan and Markit in association with ISM and IFPSM – registered a reading identical to the no-change mark to signal a broad stagnation of industry. Rates of expansion in production and new orders also eased to a near-stagnation, while the pace of contraction in new export business was one of the steepest during the past three years. The muted performance of manufacturing was also reflected in the labor market, as staffing levels fell for the fourth straight month. National PMI data signaled that where growth was recorded this was mainly centered on North America and Europe. Downturns continued in Asia and South America. (1) Europe still struggles with deflation, an effect of a 10.2% unemployment rate. The final Markit Eurozone Manufacturing PMI came in at 51.5 in May and 51.7 in April 2016, up from a flash May reading of 51.5. Six out of the eight nations included in the eurozone manufacturing survey reported expansions during May. The Netherlands, in first position of the PMI growth rankings, and third-placed Germany were the only countries to report faster rates of growth. Manufacturing PMIs in the Euro Area averaged 49.94 from 2007 until 2016, reaching an all time high of 59 in February of 2011 and a record low of 33.50 in February of 2009. (2) In Japan, the safe haven yen look like it hit a low at 106 in May. It is was 108 in early June, 114 in early March, and 119 in January, when the shock negative rate announcement hit. The yen is well off its 125 level seen in June 2015. (3) China keeps its +6.5% GDP growth target. The PBOC produced six rate cuts in 2015. Other measures, like ‘national team’ share buying supported flailing Chinese stocks at mid-summer. They threw ‘speculators’ in jail, investigated stockbrokers, and bank margin lending and eliminated short selling. It’s still a rigged situation, with plenty of stock manipulation going on. But the fundamental outlook has improved. Housing has turned up in major cities. Services look strong. Manufacturing stabilization is all there to talk about. President Xi is chatting up stocks again. The health of China’s manufacturing sector continued to decline in May. Output and new orders both fell slightly. At the same time, job shedding persisted across the sector, with the rate of reduction remaining close to February’s post-global financial crisis record. Weak demand conditions underpinned further falls in both purchasing activity and inventory holdings in May. Inflationary pressures appeared to cool slightly, however, with input prices and output charges both rising at weaker rates.
11. 11. Stock Market Outlook 11 Adjusted for seasonal factors, the Purchasing Managers’ Index™ (PMI™) – a composite indicator designed to provide a single-figure snapshot of operating conditions in the manufacturing economy – dipped to 49.2 in May, down from 49.4 in April, and below the neutral 50.0 value for the fifteenth successive month. That said, the PMI reading remained consistent with only a marginal deterioration in the health of the sector overall. Manufacturing PMIs in China averaged 49.36 from 2011 until 2016, reaching an all time high of 52.30 in January of 2013 and a record low of 47.20 in September of 2015.  In another Asian space, Modi’s India stays on track for +7.5% annual GDP growth. For Brazil, GDP data show a deeper -6% annual recession. My calls? Brazil and Russia are well past technical share bottoms. Fundamentals have turned. One subscriber in Brazil called it a deformed ball. You don’t know how it is going to bounce. Note: 68% of S&P500 revenues come from North America, 11% from Europe, and 10% from Asia. DJIA Similar to the S&P500, the Dow move can get to a new high this year. NASDAQ Stay positive long-term on IT. Info Tech is in the top half of the Zacks Industry Ranks. However, IT cap-ex and consumer spending seems weak in the first half. Q2 looks for -7.2% from the sector. Q1-16 IT sector EPS growth looked poor at -6.0%. Q4-15 was +3.7%. Q3-15 was +4.7. Q2-15 was +3.7%. Q1-15 was +2.7%. Across 2016, IT tallies +2.6% EPS growth and +3.1% revenue growth. Zacks Rank #1 IT remains worth buying and holding long-term. AAPL is a disproportionate part of the QQQs Shares briefly broke below $100 a share in August 2015 in the Algo-electronic assisted panic, and re-tested that August low at $92 in early 2016. Share are $93 after iPhone sales dipped. The S&P500 is rising without AAPL, thanks to the turn in Energy and Materials. Bottom-up S&P 500 Earnings from Zacks Research System (ZRS) Bottoms-up projections say earnings were -1.1% in 2015. They could be +0.8% in 2016 and +13.4% in 2017. S&P 500 earnings were up +4.8% in 2014. Top-down S&P 500 Earnings from ZRS The 2016 top-down estimates look a bit more optimistic. Top-down forecasts see less than +4.0% annual earnings growth for 2016 and +9.5% in 2017. Russell 2000 Russell 2000 stocks lead as markets go “Risk-on”. Fast-growing small U.S. companies beat consensus more easily. A 2016 “risk-on” rally remains my call, after two years of poor performance. The backdrop: Always be mindful of illiquid small cap shorting. In ‘Risk-off” trading, shorts can cut many small cap shares down by -50%. Fed Funds A first Fed rate hike happened in Dec. 2015. Odds are data dependent across 2016. It’s not a pre-set course, but 2 more (June/July and Dec?) look likely. A sound U.S. payroll outlook helps. Global growth and S&P500 EPS upgrades would help more. The FOMC holds off if stocks get hit hard; the USD gets too strong; and U.S. exports fall too much.
12. 12. ZACKS INVESTMENT MANAGEMENT 12 10-yr Treasury Europe “QE” now stretches into 2017. Initially, the ECB set a March 2015 to Sept. 2016 monthly bond-buying plan. Limited by European “QE”, the U.S. long risk-free rate look stuck. A 10-year from +1.7% to +2.5% in 2016 summarizes. Right now, 1.8% is here. Upgraded European GDP growth in 1H-16 remains consensus. Remember, a rosy consensus has usually disappointed by mid-year. The ECB remains pressured to lift growth and reverse deflation. Corporate High Yield and Investment Grade Bonds IG corporates offer the solid coupons. Record low risk-free rates drive corporate bond demand. Cash on balance sheets remains impressive. Investors should own them. However, only a 3.5% to 4.5% total return may be on offer. In our March poll, CIOs thought High Yield spreads would tighten. They have been right. Municipal Bonds State tax efficient munis look best for income investors. Having written that, all bond classes get sold with rising Fed rates. Hold to maturity as U.S. rates rise. Note: In our poll, CIOs were neutral or negative on munis in March 2016. WTI Oil Our oil price outlook in June is tied to OPEC politics, to busted “fracker” rig counts, and to enhanced summer demand from cheaper gasoline. Any global GDP outlook driving oil demand mixes better U.S. gas demand, regulated gas costs in China, and Europe turning. Cheap Sunni Saudi oil production hammers higher cost North American shale producers. Shia Iran is no friend of this OPEC, which depresses the price outlook too. February 2016 put an oil bottom in at $26 a barrel. We could see more than $50 this year. Look for $54 or $57 a barrel by late next year, maybe sooner. Commodities GSCI Index I write using fresh May 2016 data. The long play in softs is coffee (+7.1%) and wheat (+11.4%) Live cattle prices may head down -11.5% more. Nickel and Aluminum get a +11.75% and +9.87% bid in the latest 12-month look. Tin? -2.6%%. Platinum prices? Flat. Copper may rise +6.3%. Consensus has gas-at-the-pump price flat. Oil and Nat Gas look bullish in 12 months, up +12% and +51%, respectively. Zacks called a commodities bottom in mid-Feb. 2016. Gold Gold trades at $1217 in early June. Our range-bound call remains. Gold prices can fluctuate above $1200, but no further. The low end of this range is $1000. Gold price downside hails from a low U.S. 5.0% unemployment rate and on any improvement to the global GDP outlook. Gold price upside hails mostly from financial scares – think about a financial contagion from bankruptcies in Oil & Gas land. Zero and negative rate actions are upside catalysts. The recent surge in buying was driven by gold ETF buying. That’s speculative. NOTE: About Zacks Rank Sector & Industry Forecasts Coming Up Next -- Zacks Research System (ZRS) updates the Zacks Ranking System regularly; and groups each company into three aggregates. Each of the ranking aggregates still apply the standard proprietary Earnings Estimate Revisions system, but they help sort things out within a top-down context.
13. 13. Stock Market Outlook 13 Zack aggregates are: - A 16 Sector grouping (versus the S&P500’s 10 sector groups), - A 60 mezzanine grouping, known as “Middle” or Zacks M-Rank. - And finally, a 250+ industry grouping, we refer to internally as the X- Rank. The table in section 6, running four pages long, applied the consolidated ranking information from the 60-industry, Zacks Middle, or M-Rank. Industries titles listed along with the Zacks Middle Industries are S&P500 Industries, with revisions and additions to reflect specific Zacks industries.
14. 14. ZACKS INVESTMENT MANAGEMENT 14 Top-Down Zacks Rank 4. ZRS Chart of the Month The chart below shows the S&P500 Price to Free Cash flow ratio over the last 20 years. Here are 3 key cycle points in the chart-- This valuation ratio was between 30 and 35 running thru the 2000 Tech bubble; and between 20 and 25 during the 2002-2007 up cycle. Where is it now? It has gone from a low of 7.23 in 2009 to between 17 and 18 now. This up cycle is less overvalued than both the 2000 tech bubble and the 2002-07 housing/bank driven cycle. That’s good news. As far as the last three years of Free Cash Flow goes, the above S&P500 sector chart shows where Free Cash Flow is piling up in this U.S. economy. Tops at 10% are Financials (down from 16% 3 years ago), followed by Telcos at 8%, then Info Tech at 6% (down from 8% three years ago) and Health Care at 4% (flat the last 3 years). Bottom is Energy and Utilities near the 0% Free Cash Flow mark. Only Health Care held up among the top Free Cash Flow sectors.
15. 15. ZACKS INVESTMENT MANAGEMENT 15 5. Zacks Rank S&P500 Sector Picks See the next 4 pages for all of the details… The U.S. consumer showed up strongly in late May macro data. It clearly helped analysts to upgrade earnings estimates for consumer sectors. In short, Consumer Staples and Consumer Discretionary are back to the top of the pack. Materials --another Very Attractive sector—were led by industries that supply consumers too. Interestingly, deep defensives got upgraded to Market Weight. Financials are at the back of the heap. That shows the super low interest rate environment keeps a bid on dividend paying defensives and off rate earning banks. (1) Consumer Staples upgraded to Very Attractive. The Food and Soaps & Cosmetics Industries lead the way. Tobacco, Food/Drug Retail, and Misc. Staples all look good too. (2) Materials keep on at Very Attractive. The best is Chemicals and Metals-non-Ferrous, Paper, and Containers & Glass. Those are tied to consumption. (3) Consumer Discretionary upgraded to Attractive. Industry leaders are the big cyclicals of Home Furnishing- Appliances and Autos/Tires/Trucks. Publishing and Other Consumer Discretionary also look good. (4) Health Care falls back to Attractive. Medical Care is best. Drugs and Medical Services are Market Weight. (5) Industrials fell one notch to Attractive. Metal Fabricators, Business Services, Railroads, and Electrical Machinery lead the way here. (6) Telcos are a Market Weight. (7) Utilities are a Market Weight. (8) Energy falls back to a Market Weight. Oil & Gas Integrated looks best. Drillers remain in the tank, along with Oil-Misc. (9) Info Tech fell to a Market Weight. The best is Electronics. The worst is Computer-Office equipment. (10) Financials are still Unattractive. The best is Real Estate and Banks-Major and Banks & Thrifts. The worst is Investment Funds.
16. 16. Stock Market Outlook 16 6. Zacks Rank June Industry Tables Zacks Forecasts for S&P 500 Industries (May 31, 2016) Industry Portfolio Rating: Very Attractive (2.00 to 2.64 Zacks Rank) Attractive (2.65 to 2.81) Market Performer (2.81 to 2.99) Unattractive (3.00-3.20) Very Unattractive (3.21 or worse) Consumer Staples VERY ATTRACTIVE Home Furnishing- Appliance (2.02) Autos/Tires/ Trucks Auto Retail, Automotive Manufacturers, Tires & Rubber, Auto Parts & Equipment Distributors (2.30) Publishing (2.67) Other Cons Disc (2.75) Apparel Footwear, Apparel & Accessories, Apparel Retail (2.87) Leisure Service Casinos & Gaming Hotels Leisure Products Restaurants (2.95) Media Movies & Entertainment Cable & Satellite, Advertising (3.09) Non-Food Retail/ Wholesale Department Stores, General Merch. Stores, Specialty Stores (3.20) Consumer Electronics (4.00) found via: Internet Retail Computer & Electronics Retail Photographic Products Consumer Discretionary ATTRACTIVE Home Furnishing- Appliance (2.02) Autos/Tires/ Trucks Auto Retail, Automotive Manufacturers, Tires & Rubber, Auto Parts & Equipment Distributors (2.30) Publishing (2.67) Other Cons Disc (2.75) Food Food Distributors Packaged Foods (2.86) Food/Drug Retail Hypermarkets & Supercenters (2.92) Beverages Soft Drinks, Brewers Distillers & Vintners (3.00) Agri-business (4.01) Energy MARKET WEIGHT Oil & Gas – Integrated (2.73) Energy - Alternate Sources (2.92) Oil Exp & Prod (3.01) Coal & Consumable Fuels (3.03) Oil & Gas Prod. Pipeline (3.09) Oil & Gas Drilling (3.15) Oil Misc. – (3.45)
17. 17. ZACKS INVESTMENT MANAGEMENT 17 Industry Portfolio Rating: Very Attractive (2.00 to 2.64 Zacks Rank) Attractive (2.65 to 2.81) Market Performer (2.81 to 2.99) Unattractive (3.00-3.20) Very Unattractive (3.21 or worse) Health Care ATTRACTIVE Medical Care Health Care Distributors, Health Care Supplies, Health Care Facilities, Managed Health Care (2.68) Drugs Biotechnology, Pharmaceuticals (2.82) Medical Products Life Science Tools & Services, Health Care Equipment (2.97) Financials UNATTRACTIVE Real Estate (REITs), Real Est. Mgmt& Dev. (2.88) Banks-Major Regional Banks Diversified Banks, Other Diverse Financial Srvs. (2.90) Banks & Thrifts (2.93) Invest Banking & Brokering (3.00) Finance Specialized & Consumer Finance (3.09) Insurance Insuran Brokers Multi-Line Insurance Life & Health Insurance Property & Casualty Insurance (3.20) Investment Funds (3.49) Industrials ATTRACTIVE Metal Fabricating (2.77) Business S’vices HR & Employment Services Trade Comps & Distributors (2.81) Railroads & Trucking (2.82) Machinery Electrical Electrical Comp. & Equip. (2.83) Industrial Products-Services (2.86) Machinery (2.88) Conglomerates (2.94) Aerospace & Defense (2.94) Business Products Commercial Printing Office Services. & Supplies (2.97) Airlines Air Freight & Logistics (2.97) Construction – Building Services (3.04) Pollution Control (2.83)
18. 18. Stock Market Outlook 18 Industry Portfolio Rating: Very Attractive (2.00 to 2.64 Zacks Rank) Attractive (2.65 to 2.81) Market Performer (2.82 to 2.99) Unattractive (3.00-3.20) Very Unattractive (3.21 or worse) Info Tech MARKET WEIGHT Electronics Electronic Components Equipment & Instruments Computer Hardware, Computer Storage & Peripherals (2.71) Computer Software- Services Home Entertainment Software, Application Software, Systems Software, Internet Software & Services (2.77) Misc. Tech Data Processing & Outsourcing Services Consulting & Services (3.01) Electronic- Semiconductors Semiconductors Semiconductor Equipment Electronic Manufacturing Services (3.04) Telco Equip (3.06) Computer-Office Equipment Office Electronics, (4.01) Materials VERY ATTRACTIVE Chemicals Fertilizers & Ag. Chemicals Industrial Gases Specialty Chemicals Diversified Chemicals (2.45) Metals non-Ferrous Diversified Metals & Mining, Gold, Aluminum, (2.57) Paper Paper Packaging Paper & Forest Products, (2.74) Containers & Glass (2.75) Steel (2.90) Building Products/ Construction Materials, (2.97)
19. 19. ZACKS INVESTMENT MANAGEMENT 19 Industry Portfolio Rating: Very Attractive (2.00 to 2.64 Zacks Rank) Attractive (2.65 to 2.81) Market Performer (2.82 to 2.99) Unattractive (3.00-3.20) Very Unattractive (3.21 or worse) Telecom Services MARKET WEIGHT Utility Telephone (2.61) Telco Services Wireless Telecom Services Integrated Telecom Services (2.91) Utilities MARKET WEIGHT Utilities Electric Power (2.90) Utilities – Water Supply (2.93) Utilities Gas Dist. (3.28)
20. 20. ZACKS INVESTMENT MANAGEMENT 20 7. June Sell-Side and Buy-Side Consensus at a Glance Sell-Side Consensus Top-Down S&P 500 End-Of-Year Target In early 2016, 14 sell-side strategists pegged year-end 2016 annual returns from -0.5% (S&P500 at 2050) to +12.9% (S&P500 at 2,325). Five bulls looked for +8 to +12.9% returns. Six moderate bull sell-side strategists looked for +4 to +7% returns. Three sell-side strategists showed up as relative bears. They looked for -0.5% to +2% returns. There were 3 downgrades in Feb 2016 by the sell-side. The 2015 sell-side call was identical to the 2016 outlook at the start. Importantly, there was no change to sell-side outlooks in mid-summer 2015. In years past, we saw mid and late year upgrades to S&P500 targets. In June 2014, three sell-side strategists out of 13 raised year-end targets. Five kept targets fixed. Two more raised their targets late in 2014. 0% was the actual return in 2015. The full sell-side average in January 2014 was for an S&P500 return of +7.5%. +11% was the actual annual return in 2014. In early 2013, sell-side strategists forecasted S&P500 returns between -2.5% and +13.2% without dividends. Bulls moved up forecasts at mid-year 2013. Broad pessimism really missed the mark that year. +32% was the actual return. Other Sell-Side Views The “Equity Risk Premium” is an excess return the overall stock market provides above a risk-free fixed income rate. This excess return compensates investors for taking on the relatively higher risk of equities. A number of sell-side strategists believe the equity risk premium is still a positive force for stocks. It looks to be 6.0% now. Bullish sell-side strategists measured the S&P 500 equity risk premium at +6.2% in 2013 and 6.0% in 2014 instead of the +4.2% average of the recent past. It peaked at 7.4% during 2012. The lower rates go, the more incentive there is to buy stocks. In May 2016, the US Treasury trades around 1.80%. In January 2016, it traded at 2.2%. In March 2015, this benchmark was trading at 2.1%. In June 2014, it was 2.6%. In March 2014, it was 2.8%. Bottom-up S&P 500 Earnings Bottom-up strategists see +2.5% earnings growth in 2016 and +13.3% earnings growth in 2017 for the S&P500 index companies. Negative EPS growth came with overall GDP growth in 2015. EPS Consensus makes a call for around +3.0% U.S. real GDP growth rate in 2016 -- and blowout EPS and GDP growth in 2017. The Zacks view difference? 2016 can achieve decent +5% nominal S&P500 earnings growth. Personal consumption spending steadies the system. With poor earnings and revenue y/y growth rates in 1Q-16, markets look to 2Q and 2H- 2016. They will forget about a lousy Q1-16, if guidance improves the outlook.
21. 21. Stock Market Outlook 21 Top-down S&P 500 Earnings Top-down strategists see -1.1% annual earnings growth in 2015, +4.0% in 2016, and +9.5% in 2017 for S&P500 companies. We saw a modest valuation correction from Aug. 2015 thru Feb. 2016 based on weak EPS -- not weak GDP. Small Cap, Mid Cap, and Large Cap stocks From sell-side reports, we gleaned that returns for small cap stocks in 2016 could be between +10.50% to +12.50%, with +9.0% to +11% for mid caps, and +7.8% to +9.8% for large caps. The Zacks view difference? Stay bullish on growth indexes, large, mid, or small. In particular, focus on small and mid caps. These have more room to run. Buy-Side Consensus S&P 500 and Russell 2000 From our March 2016 survey, buy-side consensus showed 77% of CIOs stayed positive, versus 83% in Nov. 2015. 31% expect 0 to +5% returns in 12 months. 23% expect +5% to +10% returns over the next 12 months; 23% of CIOs expect large cap S&P500 returns to be 1o% to +15%; Three of 13 (23%) expected negative returns. The March ’16 CIO mode calls +0% to +15% returns. S&P 500 and Russell 2000: Value or Growth The latest March 2016 and Nov. 2015 survey show a buy-side preference for value over growth stocks in the large cap, small, and mid caps S&P 500 for the next 12 months. The Aug. 2015 survey indicated no growth or value preference. Note: Zacks still likes a modest growth bias, particularly on small and mid caps. Fed Funds We saw a widening of Fed Funds outlooks in our latest CIO survey. Just (8%) in the March 2016 survey showed the buy-side thinks the Fed Funds rate will be 0 to 50 basis points in 12 months. (8%) think 50 to 100 basis points. (15%) think 100 to 150 bps. (15%) think 150 to 200 bps. (31%) of CIOs see 250 to 300 bps. The CIO mode for the 5-year U.S. Treasury rate looks to be 100 to 150 bps (46%). The 5-yr was 135 bps on March 21, 2016. It was 162 bps on January 12, 2016. A year ago, it was 136 bps on April 27, 2015. Zacks agrees with Consensus. Amazing how low the 5-year rate is!
22. 22. ZACKS INVESTMENT MANAGEMENT 22 10-yr Treasury We saw a widening of Fed Funds outlooks in our latest CIO survey. Just (8%) in the March 2016 survey showed the buy-side thinks the Fed Funds rate will be 0 to 50 basis points in 12 months. (8%) think 50 to 100 basis points. (15%) think 100 to 150 bps. (15%) think 150 to 200 bps. (31%) of CIOs see 250 to 300 bps. The CIO mode for the 5-year U.S. Treasury rate looks to be 100 to 150 bps (46%). The 5-yr was 135 bps on March 21, 2016. It was 162 bps on January 12, 2016. A year ago, it was 136 bps on April 27, 2015. Zacks thinks about 1.8% to 2.7% on the 10-year. Corporate High Yield and Investment Grade Bonds In March 2016, the majority of CIOs now expect high yield spreads to come in. The Nov. 2015 CIO survey showed a majority expected credit risk spreads (i.e. the risk a bond issuer defaults) on High Yield Corporate bonds to blow up. An Energy HY blowout was seen in late 2015. But not now. It’s the reverse. Corporate Investment Grade credit spreads should be unchanged. Consensus thinks IG corporate spreads are about right. Zacks is neutral on investment grade spreads and positive on high yield corps. High yield returns at +6% have default risk from weak Energy bonds baked in that can come off. With QE in Europe, 5-year and other long-term risk-free bond rates stay miniscule. That makes Corps attractive. Municipal Bonds In March 2016 and Nov. 2015, CIOS were neutral to negative. Buy-side CIO consensus was negative in August. Fed rate hikes are playing a role. The Zacks view difference? If investors hold Munis to maturity, we like these retirement securities for their tax-free coupons. WTO Oil and Commodities GSCI Index March 2016 saw CIOs get bullish on Oil. Nov. 2015 CIOs had Oil negative. Commodities have turned to a bullish consensus in March 2016 too. The Zacks view difference? Our Oil price is tied to OPEC decisions. We got bullish on Oil later in 2016 or 2017 after a super low $27 a barrel number marked bottom. A run back to $50 can emerge, with lots of short covering volatility. A turn in macro indicators in user countries, namely GDP growth hitting in select European countries, and China growth, help oil market fundamentals. OPEC can regroup, with Russia’s help, and over ride Iran.
23. 23. ZACKS INVESTMENT MANAGEMENT 23 Gold In both March and Nov. 2015, we found a neutral to bearish cast of mind on gold. The CIOs are not interested in gold. Take profits if you own gold. Here’s a simple thought on why: U.S. “risk-on” bond and stock investors enjoy a strong U.S. labor market. That produced gold price downside. Gold buyers focus on global FX financial instability, U.S strong dollar, any surfacing of China manufacturing concern-- and Fed rate language.
24. 24. Stock Market Outlook 24 About Zacks Investment Management Zacks Investment Management, a wealth management boutique, is a leading expert on earnings and using earnings estimates in the investment process. We are a wholly owned subsidiary of our parent company, Zacks Investment Research, one of the largest providers of independent research in the U.S. We are committed to providing comprehensive personalized wealth management solutions to all of our clients through the use of equity and fixed income portfolios. Client portfolios are managed using a unique combination of Zacks independent research and Zacks quantitative models that have proven year after year to deliver superior results. Through our personalized investment process we provide all clients with the level of customization and personalization that they desire. Learn More About Our Program Contact us today to learn more about Zacks Investment Management. 800-245-2934 Disclaimer: This article is provided for informational purposes only and does not constitute legal or tax advice. Zacks Investment Manage- ment, Inc. is not engaged in rendering legal, tax, accounting or other professional services. Publication and distribution of this article is not intended to create, and the information contained herein does not constitute, an attorney-client relationship. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and profes- sional legal, tax, or accounting counsel. The original content of this document was modified to more accurately reflect the expectations of Zacks Investment Management.