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August Runup No Forecast for Autumn Growth

Wed, 29 Aug 2012

Morningstar's Heather Brilliant isn't optimistic about the market's--or Europe's--prospects for the rest of the year, though several stocks currently present buying opportunities.

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Video Transcript

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. I'm pleased to be joined today with Heather Brilliant, global director of equity and credit research, to get an update on the valuation in the market and where she is seeing the best ideas.

Heather, thanks for joining me.

Heather Brilliant: Thanks for having me, Jeremy.

Glaser: I know that this August it seems like the market actually is taking a vacation compared with some of the Augusts we've seen in the past few years. But what's happening in the market, and where does your staff really see valuation levels shaking out?

Brilliant: Generally, we have seen the market tick slowly up in August, which is nice to see. I think a lot of people really did finally go on vacation this August unlike the past few years as you've said, and that's given the market the opportunity to rally a little bit. But the volumes have been really light, and so we actually are not overly optimistic about the rest of the year. And we don't think that [the current] valuation makes the market a screaming buy right now either. On average, we're looking at a median price/fair value ratio of 0.93, which means that we think the market is slightly undervalued, but not materially so. We don't really think that equities look like a screaming buy at these levels.

Glaser: For a lot of those valuations, it's obviously lumpy, where there are probably some areas of the market that look cheap and others that look horribly overvalued. Where do you see the different sectors on that scale?

Brilliant: Interestingly, there hasn't been a lot of change in how the sectors stack up on a valuation basis. Even as the market has rallied, we thought several months ago that basic materials and energy were the cheapest sectors, and that's still where we are seeing the greatest amount of value. There is just a little bit less value than there was before.

And on the overvalued side, we had said that we thought that real estate was the most overvalued sector, and that is still the case. It's actually a little bit less overvalued than it was. It's at about 5% ahead of what we think the companies are worth.

Glaser: What are some of the big trends that you're seeing in terms of opportunities?

Brilliant: One of the reasons why we think basic materials looks so cheap is because there is a lot of concern around what's going to happen with commodity prices which have been falling out of bed lately. So one of the areas within basic materials that doesn't necessarily get overly impacted by that is steel. And there's a lot of companies in the steel sector that we think look pretty interesting. ArcelorMittal, for example, has been so beaten up that it's trading at a mere 30% of what we think it's worth. And so when you're looking at that kind of a discount, it looks pretty scary. Frankly, we're not overly optimistic about Europe for the rest of this year, but assuming that the global economy does not fall out of bed, we think that steel companies could end up doing pretty well over the long run. There's a lot of valuation opportunity there.

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Glaser: Another commodity that's been in focus is natural gas, and with the prices having been so low for so long now, are there any opportunities in that sector?

Brilliant: We think that in the long run, natural gas prices will moderate, meaning they'll come up and to a more normalized level. If that's true, we think there are some tremendous opportunities within natural gas. Suncor is one that we like in the oil sands business, which is not exactly a natural gas play but one that we think will do really well. But if you really want to look at natural gas in particular, we think Ultra Petroleum is a very undervalued stock that we still think has a ton of opportunity here.

Glaser: And then how about in the financials world? That's an area that obviously has been under intense focus for a long time now. What are the best opportunities there? Who could benefit from, say, a potential rise in interest rates in the coming years?

Brilliant: Schwab is a company that's been hurt pretty dramatically by these low rates. It hasn't been able to pass through any costs that it can normally kind of cover with a spread, and so if we see interest rates come back, we think companies like Schwab will do much, much better than they've been doing in recent years. So, we think there's a great opportunity there as they're really undervalued.

Glaser: You mentioned that you're still worried about Europe. What are some of the other risks that you think investors should be keeping in mind?

Brilliant: Well, when it comes to Europe, clearly the rally of August was not caused by anything being resolved. And so we think that once everybody comes back to work in September and there's more expectation that we will resolve some of the debt crisis in Europe, it will be more clear that there's actually not a plan for doing that. And so unfortunately, we do think that the situation in Europe is going to get worse before it gets better.

There are certainly some people out there calling for Greece to exit [the eurozone] even before the end of this year. We are not speculating on that. We don't know if the markets will end up seeing that come to fruition. But in any case, the news coming out of Europe we think will be more negative than positive over the next few months. That does create long-term opportunity, though. The valuations in Europe are so screamingly cheap at this point that we do think if an investor is really careful, you can find some interesting ideas. But we do think it will get cheaper before it gets better.

Glaser: Given that we think that there could be a sell-off potentially or that evaluation levels could come down even more, how do you when is the right time to jump into the market or to really put that money to work?

Brilliant: Well, that is the question. Generally speaking, I think we're at a time in the market when it's good to have some dry powder. But that being said, you don't want to overly try to time the market. I think that can really lead to very poor outcomes from investors as many studies have shown. We would certainly recommend dipping a toe in but keeping some dry powder so that when things get cheaper, you can add to the positions you feel the most comfortable with.

Glaser: Heather, thanks so much for talking with me today.

Brilliant: Thanks for having me.

Glaser: For Morningstar, I'm Jeremy Glaser.

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