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By Jeremy Glaser | 03-22-2014 10:00 AM

Picks and Strategies to Navigate Today's Market

Roundtable report: Morningstar strategists offer up their best ideas for a fully valued, low-yield market with few attractive choices.

Jeremy Glaser: Hi, and welcome back. I'm Jeremy Glaser, markets editor for Morningstar. Welcome to our second panel: Navigating Today's Market, a Q&A with some of Morningstar strategists.

Over the next hour, we're going to look at a number of topics, from current equity valuations to what's happening in the fixed-income market, to what's happening in the retirement, and also a bit on how to deal with manager changes.

I'm here joined today by John Rekenthaler. He is a vice president of research and also the author of the Rekenthaler Report on With Russ Kinnel, our Director of mutual fund research and the editor of Morningstar FundInvestor. Sam Lee is a strategist and editor of Morningstar ETFInvestor. Elizabeth Collins, she is the chair of our Economic Moat Committee and also the author of the upcoming book on Why Moats Matter.

Thank you, everyone, for joining me.

John Rekenthaler: Good to be here.

Glaser: I have some questions. We're also going to be taking questions from the audience. So if you have any questions, please submit them into the box next to the player and we'll try to take as many as we can.

So let's start with equity valuations and what's happening with the stock market right now. It seems like we're hitting record highs, or near record highs, on a pretty regular basis. Do you see stocks as just being too overvalued right now, Elizabeth?

Elizabeth Collins: That's a good question. Thanks, Jeremy. Actually, you're totally right. In aggregate, we think that our coverage universe--and we have a global coverage universe--is slightly overvalued based on our estimates, our analysts' discounted cash flow models, our intrinsic values. We think that our coverage universe is trading in a price to fair value estimate ratio of about 1.04; so slightly overvalued.

Now, having said that, there are pockets of opportunity and pockets of overvaluation. For example, we think that the tech sector is particularly overvalued. Meanwhile, we think that the energy sector has a lot more opportunities, and we think that the energy sector in aggregate is undervalued.

Glaser: But that doesn't seem like a tremendous overvaluation. It sounds like we're basically within that fairly valued range.

Maybe some other indicators--people talk about the Shiller P/E or some other ways of looking at the market--are flashing a much more dangerous warning sign. Sam, I know you've looked at these pretty extensively. What are your thoughts on valuation?

Sam Lee: I think markets are more on the expensive side, especially relative to other markets. The U.S. stock market trades at higher price earnings, price book, price sales than other major markets all around the world. And I think that it's in the more elevated range. The Shiller P/E right now is about 25-26. Historically, it's averaged around 15.

People will say, the Shiller P/E says that the market is grossly overvalued. But I think that while the Shiller P/E is useful, it depends on what the average is. So the 15 average comes from looking at 130-plus years of average Shiller P/Es in the U.S. Is that relevant today? I would say probably not. The equilibrium Shiller P/E, that is the fair Shiller P/E, is probably considerably elevated [versus history], because U.S. equity markets are much safer today. The U.S. is a global superpower rather than an emerging market as it was 100 years ago. Everything is cheaper, more liquid. Taxes are less onerous. Information is clearer. So, I think that justifies a higher Shiller P/E.

But that said, I do think that many investors are becoming complacent. A lot of people are piling into the markets after a good five-year run, and they're saying, wow, the market is reasonably valued or very cheap, and they're looking at recent experience and projecting that forward.

Historically, the markets' intrinsic per share earnings growth after inflation has been about 1% to 2% per annum. So, this current market rally was not driven by necessarily a huge surge in the earnings power of the U.S. economy, but it was more about the revaluation from low valuations to high valuations right now, and you can't expect that to continue indefinitely. So I'd put myself into the slightly pessimistic camp.

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