Quarter-End Insights

Stock Market Outlook: Stocks Look Slightly Overvalued Today

Damien Conover, CFA
  • The Morningstar Global Markets Index has risen 1% year to date following a quarter of increased volatility.
  • For our entire coverage universe, the market-cap-weighted price/fair value ratio is 1.03, suggesting the market is slightly overvalued.
  • On a sector-specific level, communication services continues to be the most undervalued sector, with a price/fair value of 0.86. Basic materials remains the most overvalued sector, with a price/fair value of 1.34.

The communication services sector continues to look undervalued. In Europe, regulators caused valuation pressures by rejecting a couple of mergers that would have allowed for cost-cutting and margin expansion, but we still see value in the space. From a more global perspective, narrow-moat  China Mobile (CHL) is a 5-star-rated stock in the sector. We continue to expect fixed broadband market share gains for the company in an industry that should post strong organic growth over the long term as consumption demand looks favorable in China.

Another area where we find attractive valuations is in the large-cap drug and biotechnology industry. While the overall healthcare sector looks fairly valued with a price/fair value of 1.01, the overvalued medical instruments companies are offsetting the low valuations of drug firms. We believe unwarranted concern about high drug pricing has created opportunities for long-term investors. A couple of top stock picks in the drug space are wide-moat  Roche (RHHBY) and narrow-moat  Shire (SHPG). These companies hold strong positions in oncology and ultra-rare diseases, respectively, which are two therapeutic areas with some of the strongest pricing power in the market.

On the overvalued side, the basic materials group looks significantly overvalued with a price/fair value of 1.34, much higher than the next most overvalued sector, industrials, which carries a price/fair value of 1.06. A core pillar of our basic materials overvalued call is the expectation that China demand will transition away from an investment-led growth model.

While we raised our forecasts for U.S. steelmakers on Feb. 19 in anticipation of President Donald Trump electing one of the more aggressive tariff options presented by the U.S. Department of Commerce, we continue to expect steel prices to fall in the years to come amid faltering Chinese fixed-asset investment and persistent global overcapacity. No-moat-rated  Steel Dynamics (STLD) is a stock that we expect will falter amid these challenges to a much higher degree than the investment community has factored into the company’s valuation.

Get our sector-by-sector take on the biggest themes and the best remaining opportunities today in the following reports.

Quarter-End Insights

Credit Market Insights: A Decidedly Negative Quarter for Fixed-Income Markets
Rising rates and widening credit spreads took their tool in the first quarter of 2018.

Basic Materials: Still Overvalued Despite Protective Tariffs
Our bearish view on the mining and metals sector means the basic materials coverage universe trades at a market-cap-weighted 30% premium to our fair value estimates.

Communication Services: The Most Undervalued Sector We Cover
We see value in several firms as consumers migrate away from traditional TV bundles and Europe invests in fiber and 4G.

Consumer Cyclical: Confidence, Demographics Support Consumption Gains
E-commerce market share gains present challenges for some, but trends continue to support healthy profitability for many companies.

Consumer Defensive: Looking to M&A, Online Sales for Growth
We see a few values for long-term investors amid intense competition.

Energy: Looming U.S. Shale Supply Should Temper Optimism
Huge output decline boosts near-term fundamentals, but lofty prices likely to trigger dangerous shale growth later.

Financial Services: Regulations and Interest Rates Remain in the Spotlight for 2018
We see financial services stocks across the globe as fairly valued today.

Healthcare: Values Among Drug, Biotech, and Supply Chain Firms
Innovation, consolidation, and a mixed regulatory picture for healthcare stocks in the first- quarter.

Industrials: Healthy Demand, But Few Values
Among a mostly fairly valued industrials sector, some good values remain.

Real Estate: Rising Rates Won’t Derail Strong Fundamentals
REITs have focused on strengthening their portfolios, deleveraging, and capital recycling in the face of higher bond yields and new construction.

Technology: Shift to Cloud Computing Most Important Story
The sector looks modestly overvalued as a whole, but there are some attractive firms in enterprise software and IT services.

Utilities: Under Pressure in Early 2018
Utilities sell-off presents opportunities for long-term investors.

Venture Capital Outlook: Despite Slow Volume, Liquidity Prospects Remain
We expect ample opportunity in the VC-backed IPO market as alternative liquidity routes gain popularity.

Private Equity Outlook: Carveouts on the Rise as Fundraising Slows
As dealmakers look to innovate their origination process, we anticipate a continued rise in take-privates and corporate divestitures.

Damien Conover, CFA does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.