MITCH’S Q2 2022 MARKET COMMENTARY

Keeping Perspective
in a Down Market
www.ZacksIM.com | 1-800-701-9830
A massive wave of US monetary and fiscal stimulus—
coupled with historically high corporate profit margins—
generated significant gains in stocks from the bottom of
the Covid-19 bear market through the end of last year.
Low-interest rates and a rapid shift to remote work also sent
many workers out of cities and into suburbs, which pushed
U.S. housing prices up by 30+% over the same period.

Looking back on the last three years, owning a home

and staying invested in equity markets meant capturing
a significant appreciation in overall wealth.

Though this period of wealth creation has been historic,

the era of ‘easy money’ is fading. With the Federal Reserve
shifting into hawkish monetary policy and fiscal stimulus
long gone, stocks have undergone a rapid adjustment to the
altered environment. For investors, the sharp downdraft has
no doubt rattled some nerves, but I think now is a time to
exercise patience and discipline. I’ll explain why in this report.

In This Report:
» Consumer Pessimism Has Reached All-Time Highs – What That
Could Mean for Stocks

» Did the U.S. Enter a Recession in the First Half of 2022?

» Is It Possible Inflation Peaked in June?

» Bottom Line for Investors

 Risk assets came under sharp selling pressure in the first half of
2022. Stocks endured a broad-based sell-off, with nearly every
category finishing the quarter down. But it wasn’t just stocks that
retreated. Bonds have also pulled back sharply, with the yield on

Housing prices and the 10-year U.S. Treasury more than doubling from 1.44% to 2.98%
over the course of the first six months.1 This level of tight correlation
energy stocks were between bonds and stocks is rare, but it also speaks to the rapid

among the only re-pricing event taking place in the capital markets.

two categories to Housing prices and energy stocks were among the only two
categories to experience price appreciation in the first half of the
experience price year. Energy stocks have benefitted from supply constraints tied to

appreciation in the the war in Ukraine, which sent the price of a barrel of crude oil above
$100 a barrel. In the housing market, fundamentals remain strong as
first half of the year. inventories are historically tight and millennials—many of which are
first-time homebuyers—now comprise the largest demographic in
the U.S. But rising mortgage rates have started to temper demand,
and it seems likely that the pace of price increases will moderate
going forward.

With regards to weak performance in the stock market, a little perspective is needed. Since U.S. stocks reached a
peak within a single trading day of the new year, the year-to-date performance figure looks worse than usual. To offer
perspective, even with the sharp drawdown in the first 6 months of 2022, U.S. stocks are still +35% higher than they
were on June 30, 2019—just 3 years ago.2

Taking a step back from 2022’s volatility and uncertainty, it is also important to remember that we just lived through
one of the most significant wealth creation events in history. Over the last three years, owning a home and staying
invested in equity markets has driven household net worth substantially higher. The current market drawdown is
unwelcomed, but it also follows a period of historic gains.

Zacks Investment Management www.zacksim.com 3

Household Net Worth Has Moved Sharply
Higher with Housing and Stock Prices

Source: Federal Reserve Bank of St. Louis 3

Looking forward, the era of ‘easy money’ is now unwinding. The Federal Reserve has shifted into hawkish monetary
policy, with the fed funds rate rising quickly and the Fed’s balance sheet shrinking in kind. Fiscal stimulus is also
long gone.

This is not to say that now is a time to sell stocks and houses. As investors, we know that expected returns over time
include periods when risk assets are re-priced in response to changing economic conditions like we’re seeing today. It
has been a period of historic wealth creation in a short period of time, and now the leverage is getting flushed out of the
system and financial risk assets are getting re-priced. I believe this process is best viewed as healthy, not worrisome.

There could be more runway in this bear market, but trying to forecast and time the bottom is not worth the risk. Bear
market bottoms usually occur when conditions feel terrible and pessimism reaches a peak, which we’re seeing now but
which we could also see for a few more months. Because of inflation, Americans are more unhappy with the economy
today than they were during the Great Recession, when the unemployment rate was in double digits and millions of
people lost their homes. The University of Michigan Consumer Sentiment index reached its lowest level in history.
 Source: Federal Reserve Bank of St. Louis4

Consider for a moment what this level of pessimism implies. Americans feel the economy is worse today than it was in
1974, when a deep recession and an energy crisis had people waiting in cars for hours to get gas; worse than 1980, when
interest rates were 14.5% and inflation was in double-digits; worse than 2001, when the U.S. was in recession and also
suffered the worst terrorist attack in history; worse than 2008, when the financial system nearly collapsed and millions of
people lost their homes; even worse than 2020, when a global pandemic washed the world over in uncertainty.

Extreme pessimism is being driven by higher food and gas prices

and negative media narratives, but I also think it is fair to say

Historically, extreme the pendulum has swung too far to the negative. Today, every
American who wants a job can find several to choose from. There
pessimism has been a are currently 10+ million job openings across the country—nearly

bullish signal, which double the number of typical job openings in years prior to the
pandemic. Households also have close to record amounts of cash
I think is particularly on hand—at the end of Q1 2022, Federal Reserve data showed
households with $18.5 trillion in cash in checking accounts, savings
true today as the accounts, and money market funds. Before the pandemic, that

economy slows but as figure was $13.3 trillion.5

labor market conditions Historically, extreme pessimism has been a bullish signal, which I
think is particularly true today as the economy slows but as labor
remain extremely market conditions remain extremely favorable. If the U.S. economy

favorable. fares even just modestly better than many expect to in the next
year—which I believe it can—that’s all the market may need to
produce a formidable rally. Stay patient.

Zacks Investment Management www.zacksim.com 5

 What About a Recession and Continued Inflation?
It appears possible that the U.S. economy entered a recession in the first half of 2022, which if confirmed would
mark a very shallow and atypical contraction. Recessions are most accurately characterized by declining
output, rising unemployment, and some level of dislocation in credit markets where businesses and consumers
fail to meet financial obligations. Essentially none of these conditions were met in the first half of 2022.

Economic growth is slowing, but Q1 GDP’s negative print was largely the result of a big swing in inventories and
a surge in imports, both of which detract from the GDP calculation but do not necessarily signal a sharp drop-
off in activity. Manufacturing and services indices in the U.S. have yet to dip into contraction territory this year,
and have been in expansion mode for 25 months straight.6

The past 12 recessions have also all featured rising unemployment, which we have not seen in 2022. Over the
past six months, the unemployment rate has fallen from 4% to 3.6%, and the just-released June jobs report
showed 372,000 new hires for the month, well above economist expectations. There are also ‘only’ 1.3 million
Americans collecting unemployment today, which is 400,000 fewer than before the pandemic. For context,
there were over 6.5 million unemployed Americans receiving benefits during the 2008 Financial Crisis.7

Banks are also not showing any signs of distress so far. The latest round of Fed ‘stress tests’ found that banks
could easily handle the unemployment rate soaring to 10% and a collapse in the stock market and commercial
real estate that would wipe out over $600 billion. Even with those unlikely shocks, banks would have capital
ratios of 9.7%, which is over double the 4.5% required by law. An upward sloping yield curve also suggests that
banks can still lend profitably in the current environment.8

On the inflation front, whether or not inflation starts to moderate in future months is a key question not only for
policymakers but also for equity market investors. If inflation pressures begin to subside in the second half of
the year, it could remove pressure from the Federal Reserve to tighten monetary policy so aggressively, which
could provide some relief to equity markets. This outcome would seem highly likely were it not for the ongoing
war in Ukraine combined with China’s unpredictability when it comes to “zero-Covid” and lockdowns—both of
which add substantial uncertainty to supply/demand dynamics in the global economy.

Zacks Investment Management www.zacksim.com 6

 Markets appear, for now, to be wagering that inflation pressures will ease in the coming quarters. Market-based
measures of future inflation, like the 5-year and 10-year breakeven inflation rates, have come down in recent
weeks, signaling that the bond market may be expecting lower growth and lower inflation looking ahead.
Commodity and energy prices have also broadly declined over the last month, perhaps as the market resets
expectations for global growth going forward.

Source: Federal Reserve Bank of St. Louis9

Source: Federal Reserve Bank of St. Louis10

The Federal Reserve’s efforts to cool demand in the economy may coincide with easing inflation later this year,
which may make it appear as though the Fed saved the day. But the reality of the inflation issue is that pressures
will ease once commodity markets cool off and once the supply and demand of goods find equilibrium, which
I see more as a supply issue than a demand issue. In other words, it may look like the Fed’s actions brought
inflation down, but in reality, the supply of goods and services just became more abundant.

Either way, an easing of inflation pressures would be a positive for investor sentiment and would also remove
pressure from the Fed to tighten so quickly, both of which would be good for markets. That’s what I think could
happen in the second half of the year.

Zacks Investment Management www.zacksim.com 7

 Bottom Line for Investors
The U.S. and global economy are likely headed for a period of below-trend growth, as rising
rates and inflation take a bite out of real activity. Below-trend growth is not the same thing
as a deep recession, however, and it is important to remember that the stock market’s -20%
decline in 2022 could mean a good portion of slowing growth may already be incorporated in
current prices.

A key focus now should be ensuring participation in the stock market’s recovery once it takes
hold, which will assuredly be before the economic data confirms the U.S. economy is in good
shape. Shifts in market direction often happen very quickly, which means patience is critical
right now. History tells us that once the stock market has crossed into bear market territory,
the next 12-months return for equity investors is almost universally positive. According to Dow
Jones Market Data, when the S&P 500 has fallen more than -15% in the first half of a year, it
has risen an average of +24% in the second half. In other words, being invested once the stock
market crosses the -20% level has paid off consistently throughout history.11 I continue to see
this as a time to be buying or holding quality stocks, not selling them.

Zacks Investment Management www.zacksim.com 8

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227 W. Monroe, Suite 4350, Chicago, IL 60606

1
Strategas Quarterly Review in Charts, July 5 2022.

2
Strategas Quarterly Review in Charts, July 5 2022.

3
 oard of Governors of the Federal Reserve System (US), Households; Net Worth, Level [BOGZ1FL192090005Q], retrieved from FRED, Federal Reserve Bank of St. Louis;
B
https://fred.stlouisfed.org/series/BOGZ1FL192090005Q, July 12, 2022

4
 niversity of Michigan, University of Michigan: Consumer Sentiment [UMCSENT], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/
U
series/UMCSENT, July 12, 2022.

5
The Wall Street Journal, July 6, 2022. https://www.wsj.com/articles/hiring-demand-remained-strong-as-summer-started-economists-estimate-11657099801

6
ISM, https://www.ismworld.org/supply-management-news-and-reports/reports/ism-report-on-business/

7
The Wall Street Journal, July 6, 2022. https://www.wsj.com/articles/hiring-demand-remained-strong-as-summer-started-economists-estimate-11657099801

8
https://www.federalreserve.gov/newsevents/pressreleases/bcreg20220623a.htm#:~:text=The%20Board’s%20stress%20tests%20help,scenarios%20over%20nine%20
future%20quarters.

9
F ederal Reserve Bank of St. Louis, 10-Year Breakeven Inflation Rate [T10YIE], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/
T10YIE, July 11, 2022.

10
F ederal Reserve Bank of St. Louis, 10-Year Breakeven Inflation Rate [T10YIE], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/
T10YIE, July 11, 2022.

11
 he Wall Street Journal, June 14, 2022. https://www.wsj.com/articles/bull-markets-winners-dragged-the-s-p-500-into-a-bear-market-11655184522?mod=hp_lead_
T
pos7

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