Remember the beginning of 2023? Analysts were predicting an impending recession and the next drop in stocks was just around the corner. Yet, in just over half of the year, the S&P 500 is up 20% YTD, and the Nasdaq 100 is up 45%.
In this article, I’ll explain why even better times are likely ahead and share three Zacks Rank #1 (Strong Buy) stocks that investors may want to consider buying now.
What actually happened?
Since the market is so vast and complex it would be remiss of me to try to explain it with a one time rationale. However, a major reason why everyone was so bearish at the start of the year was the recent bias and anchoring.
Cognitive biases are a significant obstacle to resolution in investing, and this is even more evident in financial news and research such as crowd psychology. Because 2022 was such a challenging year, investors assumed that we would experience another challenging year, and thus many got caught on the wrong side of the market.
Investors rely heavily on the most recent information, hence the recency bias, and base their expectations on that data.
But there was no guarantee the economy would get back on track, and with inflation low, employment remaining strong and predictions of an interest rate cut by the Fed, markets got the green light to rally. These figures were pointing to a strong year for the stock market.
With positions heavily tilted on the short side, the rally has become even more drastic as those who are short need to cover, and those who are underweight need to buy more to hold the stock.
What will happen next?
Some investors may think, “Now that the market is up so much, I should take profits and wait for a correction.” But I do think that investors following that strategy can take a substantial risk of profit. There are several signs which are suggesting that the market is in the early stages of an uptrend today, and investors may want to remain aggressive rather than let off pressure.
Of course, there are no guarantees and investors should be cautious. But I think the data points to more good times ahead.
Indices reclaim psychological level
Market indices are now above the level they were at when the rate hike started.
The S&P 500 has almost stabilized after crossing the 4200 level. To think that the stock market could go any higher than in March 2022 with the fed funds rate now at 5% is pretty unimaginable, yet here we are.
Many thought higher rates would crush the economy, yet consumers continued to spend and earnings came in stronger than expected.
energy signal strength
Strength in the oil market signals strong global economic growth.
Energy consumption is closely related to economic development. The more businesses and people spend, the more energy they need to consume.
WTI oil price is approaching a major resistance level that has kept the oil price down throughout the year. While reaching this level of resistance is also a sign of strength in the economy, if it trades above it, it will be significant.
If oil price can trade above the $83.50 level, the trend will turn much more bullish and confirm the stability of the economic growth.
interest rates are pointing down
The market is now anticipating a cut in interest rates in the future. Falling rates will improve financial conditions and spur further economic growth.
As we can see in the table below, the market now believes that interest rates have peaked, and that the Fed will start cutting rates by early next year. This is probably the most important development listed in this article.
Since the market is now expecting lower interest rates, financial conditions will remain easier, businesses and individuals will borrow and spend more, and economic activity will increase.
The market is not expecting lower interest rates yet. Investors have been pricing in low interest rates over the past several months and this has arguably been the primary driver of the market rally this year.
In the National Financial Conditions Index below, we can see that financial conditions have been easing since the week of March 24. Not surprisingly, this coincided very closely with the time when the market consolidated and began a rapid rally.
stocks to watch
So where can investors expect to find winning stocks?
The Zacks Rank #1 list is a highly efficient way to find stocks that have the best potential for near-term strength due to earnings growth. Additionally, if you can align these stocks with other bullish catalysts then investors can expect even better returns.
With lower rates on the horizon, growth stocks will likely come back into vogue. block (SQ Quick QuoteSQ – Free Report) is one such stock which can give a strong performance in the next few months. The block was completely destroyed in 2022 and turned -80% correct, but now its valuation is much more reasonable due to the decline.
And with earnings growth projected at 20% over the next 3-5 years and sales expected to grow into the teens, SQ is well positioned for the future. At just 2.4x forward sales, it is below the market average of 3.9x, and well below its five-year average of 6x.
Murphy USA (MUSA Quick QuoteMUSA – Free Report) is a fueling and convenience store company with 1,700 locations in the United States. Its earnings are undergoing strong revision and are likely to experience wider profit margins due to higher oil prices.
Furthermore, its fair valuation trades at 14.8x one-year forward earnings, which is lower than its five-year average of 15.5x and has a 0.5% dividend yield. Murphy USA has increased its dividend payout by an average of 21% annually over the past five years.
Image source: Zacks Investment Research
And finally, toll brothers (TOL Quick QuoteTOL – Free Report), a homebuilder operating in five major US regions, should be a major beneficiary of this emerging market environment.
With interest rates expected to lower in the coming year, home buyers will resume their brisk buying spree, further boosting Toll Brothers’ sales and earnings. TOL’s earnings are expected to grow 11% annually over the next 3-5 years.
The homebuilders currently rank in the top 5% of the Zacks Industry Rank and number one on the Zacks Sector Rank.
Trading at a one-year forward earnings multiple of 7.6x, Toll Brothers trades below the industry average of 10.1x and below its five-year average of 8.1x. Additionally, the stock pays a 1.1% dividend yield, which has been increased by an average of 18.4% annually over the past five years.
ground level
While investors should always be a prudent manager of risk, I believe there is a strong likelihood that we are entering an extended period of good times in the stock market. As long as we avoid another spike in inflation or a major economic downturn, the potential for a bigger rally remains.
https://www.zacks.com/commentary/2130650/we-are-so-back-3-signs-the-bull-market-is-just-getting-started
