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By Matthew Coffina, CFA and Jeremy Glaser | 10-20-2014 02:00 PM

Sell-Offs Haven't Made Many Bargains

Investors have started to pay attention to risk again, but market valuations overall don't offer much margin of safety, says Morningstar's Matt Coffina.

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Last week was a bumpy ride in the markets. I'm here with Matt Coffina--he is the editor of Morningstar StockInvestor newsletter--for his take and also to see if he made any changes or buys in his portfolio.

Matt, thanks for joining me today.

Matt Coffina: Thanks for having me, Jeremy.

Glaser: Let's start by looking at the volatility last week. What do you think was the big driver behind this? Changes in fundamentals or just fear-driven selling? What's your take?

Coffina: My sense is that it's more investor fear than a real change in the fundamentals. We did see some negative economic news, particularly out of Europe and in certain developing markets, especially China, which is really leading the way there. There are some follow-on effects in other developing markets. But these concerns have been out there for a while that China's growth is slowing and that they could be headed for a hard landing at some point. There is this ongoing deflation risk in Europe as their recovery has been very slow.

So, I don't think there was really any fundamental change last week. It's just that investors have started to pay attention to some of these risks a little more. And I think that the relatively elevated levels of valuations for stocks, particularly going into last week or into the last couple of weeks, maybe set the stage for investors to be a little more on edge, a little less willing to absorb some negative economic news when it arises, because stock prices, especially as of a few weeks ago, weren't baking in much margin of error. Or, in other words, they were baking in a pretty optimistic outlook for future economic growth, which if some news comes out that's not as positive as people are expecting, creates some downside risk.

Glaser: You mentioned valuations there. After the sell-off, after things are off their highs, do you have a big change in your view of valuation or do you see the market still as being fundamentally fully valued?

Coffina: As we stand today, the S&P 500 is only down a high single-digit percentage versus the all-time high of mid-September, and we still think that stocks are trading pretty close to fair value. We now have the median stock in our coverage universe trading at about a 4% discount to fair value versus before the most recent sell-off we were maybe at a 3% or 4% premium to fair value. So, it's still not a huge difference. We are still kind of circling fair value in the market as a whole.

Another indicator I look at is the number of 5-star stocks. As of today, there are only about 18 U.S.-listed 5-star stocks out there. So, really, we went from a situation where the market was fairly valued to moderately overvalued to a situation where now the market is fairly valued to maybe very slightly undervalued.

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