Investors Still Need to Be Picky

Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. Stock sunk on Wednesday, the biggest decline since February. Here for his take on where the market is, is Dan Rohr, he's our director of North American equity research.

Dan, thanks for joining me.

Daniel Rohr: Thank you, Jeremy.

Glaser: Let's start by setting the stage a little bit. Where did we see stocks in terms of valuations heading into the fourth quarter before we saw some of this weakness?

Rohr: The typical way to approach that question would be to look at some aggregate market measure. Something like a cyclically adjusted P/E for the S&P 500. By virtue of the fact that Morningstar covers something like 1,500 stocks globally, we could take a somewhat different approach. In a sense, a bottom-up look to inform a top-down view.

Focusing on the U.S. and focusing on the roughly 900 or so U.S. listed stocks that we cover and rolling our fair value estimates of those 900-ish stocks up into an aggregate measure of what the market's worth. We regard the U.S. stock market heading into the fourth quarter as 5%, 6% overvalued.

Glaser: But that is explicitly not a market timing call, just because it's overvalued ...

Rohr: That's right.

Glaser: But that doesn't mean that we're totally shocked to see these kinds of declines.

Rohr: Precisely. In no way can I say we predicted the timing of this particular sell-off. Nor can I say we predicted the timing of the specific catalysts that catalyzed the sell-off. I can say however that we weren't surprised by the sell-off in the sense that we felt valuations as a whole had to some extent gotten disconnected from fundamentals, making the market a bit more susceptible to a pull back, in the event bad news hit.

Glaser: Let's talk about if this has opened up any opportunities. After Wednesday's action, are we any closer to fair value now or are there areas that are looking attractive?

Rohr: That's a good question. Just as we can use our broad coverage to roll up to an aggregate market value assessment, we can do so at the sector level. You look at the 11 sectors that comprise the S&P, and only a handful are really looking undervalued in the aggregate to us. In particular, consumer defensive and communication services stand out there. Top picks of those sectors would include names like General Mills in the former and Comcast in the latter.

Rohr: At the other end of the valuation spectrum, technology looks somewhat expensive, healthcare looks expensive. But even there, we do see pockets of value in technology--Intel and some of the other semiconductor names look attractive to us. McKesson in healthcare looks cheap as does CVS. I think this is a good time for investors to be picky. Rather than buying the market as a whole, be picky about your sector exposure and your stock selection.

Glaser: Dan, thanks for the updates today.

Rohr: Thank you, Jeremy.

Glaser: From Morningstar, I'm Jeremy Glaser, thanks for watching.