Our Outlook for the Market

You know the bad news. House prices are falling. Foreclosures are rising. Icons like  Bear Stearns  have imploded because of the mortgage crisis.

Now for the good news. If you compare stock prices to underlying business value, stocks are cheaper now than at any time since 2002. 

We base this view on the fair value estimates we place on approximately 2,000 stocks. Since we began rating stocks, the cheapest the market looked was in October 2002, when the median price/fair-value ratio of our coverage universe was 0.78. In early March of this year, we came within shouting distance of that figure, hitting 0.83. Even after the recent rebound in the market, that ratio is now back up to just 0.88, meaning that the median stock we cover is 12% undervalued. (You can see all this graphically in our market-valuation chart.)

Looking across the market, each of Morningstar's 12 sectors appears undervalued to us on a median basis. As the chart below shows, each sector is cheaper as measured by median price/fair-value ratios than it was three months ago. And some of the relatively pricey sectors at the end of last year--telecom, health care, utilities--have fallen the sharpest in 2008.

Sector Valuation Changes
	Current Median Price/Fair-Value	Three Months Prior	Change ( % )
Business Services	0.88	0.97	-9.2
Consumer Goods	0.89	0.94	-5.3
Consumer Services	0.78	0.84	-7.1
Energy	0.93	0.94	-1.1
Financial Services	0.88	0.92	-4.3
Hardware	0.85	0.93	-8.6
Health Care	0.90	1.00	-10.0
Industrial Materials	0.90	1.00	-10.0
Media	0.91	0.92	-1.1
Software	0.88	0.96	-8.3
Telecommunications	0.90	1.00	-10.0
Utilities	0.93	0.98	-5.1
Data as of 03-14-08.

None of this means stocks can't fall further. After all, our fair value estimates may be too optimistic. The market can also shoot well above or below intrinsic value for extended periods. But just as it's a lot better to be a home buyer today than it was two years ago when everything seemed so rosy, we think it's a better time to be shopping for stocks today now that prices have come down.

Below, we dig into each sector in more detail, laying out which areas--and which stocks--appear cheapest to us at the end of the first quarter.

Consumer
What do the next few quarters look like for the U.S. consumer?

Energy
Energy prices rise despite a dramatic slowdown in economic activity.

Financials
We see a few good investments amid the maelstrom in financials.

Hardware
Some promising opportunities exist.

Health Care
Health-care spending is likely insulated from larger economic bumpiness.

Industrials
Overseas demand and a weak dollar are driving strong industrial sales.

Media
Microsoft is making a bold move to catch Google in the search business.

Software
Software stocks for turbulent times.

Telecom
A pullback provides opportunities in the defensive telecom sector.

Utilities
Utilities shed their 'safe-haven' trait in the first quarter.