Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Every Monday morning I sit down with Morningstar Research Services’ chief U.S. market strategist Dave Sekera to discuss one thing that’s on his radar this week, one new piece of Morningstar research, and a few stock picks or pans for the week ahead. On your radar this week, Dave, are a couple of economic reports. What are they, and why are you watching them?
Dave Sekera: Good morning, Susan. It’s actually a relatively quiet week to start. We do have the Purchasing Managers Index, and that’s just an indication whether or not people think, specifically purchasing managers, whether or not the economy is strengthening or whether or not if it’s slowing. A reading there above 50 indicates that the economy is expanding, a reading there below 50 means a contraction.
But the real action this week is all going to be on Friday. That’s when we have nonfarm payrolls and unemployment. Essentially, what we’re looking for is a report that’s not too hot and not too cool. We do think that the rate of economic growth is going to be slowing but not slowing too much. I think what the Fed is going to be looking for here are for indications that employment is starting to cool but not to cool too much that it might end up causing a recession.
Dziubinski: Let’s move on to some new research from Morningstar. As viewers probably know, Charlie Munger, who worked alongside Warren Buffett at Berkshire Hathaway BRK.B for decades, died last week at the age of 99. Morningstar’s longtime analyst on Berkshire Hathaway published a note after Munger’s death, and viewers can access the link to the note below this video. Now, Dave, what does Munger’s death mean for Berkshire Hathaway, and has Morningstar changed its fair value estimate or any of its ratings on the company after Charlie’s passing?
Sekera: As you know, Warren Buffett has always been the public face of Berkshire, but I think Charlie Munger’s contribution to the long-term success of Berkshire, it’s probably always underappreciated by the market. As you noted, Gregg Warren did publish a note. He’s our equity analyst who’s covered Berkshire for years and years at this point.
So, there is no impact to our fair value. There’s no impact to our wide economic moat rating. In fact, even as long as 10 years ago we had already been stating that Berkshire would survive the eventual departure of Warren and/or Charlie. In our opinion, we think that long ago they already started laying the groundwork for this transition. At this point, we think Berkshire’s culture of management and autonomy and entrepreneurship has all really become institutionalized within the company. Now, I’d also note too, that both Warren and Charlie have been training those asset managers, and in fact, those asset managers are already running money at Berkshire.
Dziubinski: Charlie will be missed, especially that dry wit of his, for sure. Let’s turn to some new research that you’ve been working on, Dave, and that’s your market outlook for December, which just published on Morningstar.com. The stock market performance was actually really strong in November, up more than 9%. Talk a little bit about sectors that did the best during that month and maybe some of the worst, and anything that stands out to you from a sector perspective.
Sekera: Well, what really stands out is what’s called the Santa Claus rally. That definitely came early this year. Historically, December is one of the strongest months of the year, and that’s why it’s called the Santa Claus rally. But this year, the markets really started to take off in early November and specifically right after the last Fed meeting. The reason being was that the market really at that point started pricing in no more additional rate hikes, which as we’ve discussed for a while now, our opinion has been since the July meeting that that was going to be the last rate hike of this monetary policy tightening cycle.
Now looking at the performance within the overall market, the tech sector again was the leader in November. Tech was up 13.3%. But I’d note here it wasn’t just those “Magnificent Seven” stocks. And, in fact, in November, the Magnificent Seven only accounted for about a third of the market’s gains, whereas year to date, the Mag Seven account for two thirds of the market gains.
Following tech was real estate. Real estate was up 12.2%, another sector that we thought was pretty undervalued. And then from there, we look at consumer cyclicals. Those were up 11.4%, and financial services up 11%. So, according to our valuations, all of these were some of the most undervalued sectors that we’ve seen coming into the year as well as for most of the year. Now to the downside, energy was the lagger. That actually fell 1% last month.
And then, let’s take a look at returns here by capitalization. Large-cap stocks were actually up the least this past month, only increasing 9.2%, whereas mid-cap stocks and small-cap stocks were both up more than that. Probably too early to start calling it a trend, but according to our valuations, we’ve noted for the past couple of months that we do think that for the market rally to continue from here, it would need to really broaden out away from some of those large caps and into mid-cap and down into small caps as well.
Dziubinski: Going into December, Dave, how do stocks look today? Is the market undervalued, overvalued, or somewhere in between?
Sekera: First, just looking back over the past couple of months, last month in our November market outlook, we noted just how undervalued stocks have become as compared to our fair valuations at the end of October. So, at the end of October, the market was trading at an 11% discount to those valuations, and we noted not only was the market significantly undervalued at that point but has only ever traded at that much of a discount or more to our fair value only 12% of the time going all the way back to 2010.
Now following this dramatic runup in November, the market is still undervalued, but it’s now only trading at about a 4% discount to our fair value. So, it’s still undervalued but to much less of a degree at this point. I kind of think the Santa Claus rally has probably run its course, and I think it’s probably going to start running out of steam here through the end of this month.
Dziubinski: Are there any sectors that look more attractive from a valuation perspective now than they did say a month or two ago?
Sekera: It’s really only that energy sector that did pull back, really taking a look at energy and looking at not only the pullback in some of those stocks but maybe a couple of updates in our valuations as well. Energy is now trading at an 8% discount to our fair value as opposed to a 5% discount last month. So, again, starting to look a little bit more attractive here, starting to see some more interesting opportunities pop up.
Dziubinski: I want to ask you specifically about utilities because we talked at length on a previous episode in October about the tremendous opportunity Morningstar saw in the sector at that time. Is there still opportunity there?
Sekera: There is. There’s still opportunity in the utility sector. Now, it did rise over 5% in November, so at this point it’s currently trading at about a 7% discount to our fair value. But again, when I take a look at it by historical standards, it’s still very undervalued. If we look at the amount of time since 2010 that it’s traded at this amount of a discount or more, it only traded this undervalued, in our view anyway, only 3% of the time.
Dziubinski: Wow. Let’s spin that on its head. Do any sectors look way overvalued today that investors might consider pulling back in?
Sekera: It’s got to be technology. Technology was up over 13%, and at this point, it’s now trading at an 8% premium to our fair values. And what I look at it over the course of the year, and specifically for more active investors, we do think now is a good time to move back to an underweight position within technology, a very good time to take profits in some of those stocks that have become overvalued and overextended, in our view.
And I’d note, technology has been very volatile here in 2023. At the beginning of the year in our 2023 market outlook, we had actually recommended an overweight position. That sector was trading at a 19% discount to our fair values at the beginning of the year. Of course, as that sector moved up in the beginning of the year, hit our fair value, we moved to a market-weight position. Then by midyear, as the stock market continued to go up for tech, we actually had moved to an underweight. And then, we ended up moving back to our market weight once valuations started coming back down again in August and September. And following that market weight, it’s probably now time to go back to an underweight.
Dziubinski: Let’s pivot a little bit and look at the market through the lens of investment style. From a growth/value perspective, what should investors be thinking today?
Sekera: I think as you’d expect with tech, cyclicals, and communications being up the most here in November, by style, the growth category itself was up 11.6%. Core and blend were up 8.0%, and value is only up 7.3%. I think based on valuations, I do think now is probably a good time to start readjusting your allocations by category as well.
We continue to believe that value should be an overweight. Value stocks traded at about a 14% discount to our fair value. Core and blend stocks are only at a 3% discount, so that’s pretty close to the market average. I think now would be a good time to consider moving to a market-weight position there from an underweight. But looking at growth, that’s now trading at a 2% premium. Now granted that’s not that much of a premium, but with value stocks at such a discount, in order to have that overweight in the value category, you’ve got to underweight something. So in this case, according to our valuations, I think now is probably a good time to start underweighting that growth category.
Dziubinski: And then lastly, from that large-cap/small-cap perspective, it looks like, as you mentioned, small-cap stocks performed in line with large-cap stocks in November, which is kind of refreshing. Yet, even so, small-cap stocks still must look really undervalued when you compare them to large caps, right?
Sekera: Dmall-cap stocks were up 9.5%, and that just kind of edges out large-cap stocks were up I think 9.2%. And then, mid-cap stocks were the winners. They came up 10.3%. But as you mentioned, according to our valuations, small caps are still the most undervalued, trading at a 24% discount to our fair value. Next up are the mid-cap stocks, still undervalued, trading at an 11% discount. And large-cap stocks are actually trading a little bit better than the broad market discount. Large caps are only at a 1% discount.
Dziubinski: It’s time to move on to the stock picks portion of our program. This week, you’ve brought viewers seven attractive mega-cap stocks that could move the market in 2024. Now Dave, what makes you think these seven stocks you’re going to talk about will have an outsize impact on market returns next year maybe the same way that the “Magnificent Seven” did in 2023?
Sekera: Yeah. At this point, according to our valuations, the “Magnificent Seven” generally have kind of run their course. In fact, only one of those seven is still undervalued, whereas at the beginning of the year, six of those were undervalued. What I did here is I conducted a quick screen for undervalued stocks, and then I ranked them by which ones we think have the most upside in market capitalization terms as compared to our fair values. So, these are the stocks that, based just really on their size and their upside potential, that we think will have some of the broadest impact to the broad market indexes.
Dziubinski: Let’s get right into the picks. Your first two are actually two stocks from the “Magnificent Seven” of 2023, and that’s Alphabet GOOG and Amazon AMZN. So as we’ve talked about many times, both are having pretty spectacular years, but you still think they have room to run in 2024. Why?
Sekera: We do. Specifically, Alphabet is the last of the “Magnificent Seven” that we still rate as being undervalued. That’s a 4-star-rated stock, trades at an 18% discount to our fair value. Now, I know Amazon has run up and up this year. It is a 3-star-rated stock, but it is still trading at about a 5% discount to our fair value. And, of course, just based on the size of Amazon itself, a 5% increase there is a large impact to the market cap of the overall market.
And I’d say both of these companies are still going to benefit from a combination of long-term secular growth within the cloud business as well as from additional digital advertising. Taking a look at Alphabet, we still think that there’s some increase that’s yet to come in their margins just as they see some monetization in YouTube. And then, with Amazon, that’s benefited from the long-term trend for e-commerce. We still continue to expect that, over time, to still take share from the retailers.
Dziubinski: Now next on your list is Berkshire Hathaway. That certainly qualifies as a mega-cap and is undervalued. Tell us about Morningstar’s current take on the stock.
Sekera: Berkshire is a 4-star-rated stock. The Class B shares do trade at an 11% discount to our fair value. Of course, Berkshire does not pay a dividend yield, but we continue to rate Berkshire with a wide economic moat. And I’d also point out here that we do rate Berkshire with a Low Uncertainty Rating, and there aren’t that many stocks that have a Low Uncertainty Rating When I look at our equity coverage, only 6% of our coverage earns that Low Uncertainty Rating.
Now I would note I think Berkshire is a pretty tough stock to value, and there’s really two main points to that. First, I think the market is probably undervaluing the private equity portion of their portfolio. Those are the companies where Berkshire bought them out and owns the entire company. But I also think the market is just unsure here as to how to be able to price in the key-man risk as far as Warren Buffett. So, again, while he appears to be in pretty good health, you do have to note he is 93 years old. But we believe there is a very strong succession plan that’s already put in place. The asset managers that work for Warren, they’ve all been able to benefit from his mentoring over the years. We do expect, going forward, even after Warren is no longer managing the money, that they will still manage the assets there in a very similar style to how he and Charlie had been managing it.
Sekera: Exxon is actually down 6.6% year to date. Recently, we actually bumped up our fair value a bit to $123 a share. So it’s a 4-star-rated stock. It trades at a 16% discount, has a 3.7% dividend yield, and we do rate the company with a narrow economic moat.
Now, Chevron interestingly started the year as a 2-star-rated stock. That stock is now down 19% thus far this year. It did hit a 4-star rating. It just moved back up into the bottom of the 3-star range right now. But again, it’s paying a 4.2% dividend yield and it does have a narrow economic moat.
Sekera: Comcast is one I don’t think you and I have actually talked about before, but that’s currently rated 5 stars, trades at a 30% discount, and has a 2.8% dividend yield. It is a company that we rate with a wide economic moat, meaning we do think that they have long-term durable competitive advantages. And I spoke to Mike Hodel, he’s the equity analyst who covers it, and I think what’s going on here, in his view, he thinks the market is just overestimating the amount of deterioration in its traditional TV business and probably underestimating the growth that we think the company will have in gaining new broadband customers over time, as well as we do think that they do have very good pricing power over the longer term.
Verizon, this is one that’s the opposite. You and I have talked about this one ad nauseam a number of times. So, again, a 5-star-rated stock. It trades at a 30% discount, almost a 7% yield. A good stock where while it’s undervalued, it’s one where you’re going to get paid to wait. A company we do rate with a narrow economic moat. I think the long story short here, we expect that over time, the wireless industry is going to start acting more like an oligopoly, which means that they’ll compete less on price. And we do expect that the operating margins will be able to expand over time, which is why we think that this, as well as AT&T T, are both pretty significantly undervalued.
Dziubinski: And I think you meant to say Comcast there, right? Comcast and Verizon are undervalued,
Sekera: Comcast is undervalued, Verizon is undervalued, and AT&T is similar to Verizon. It’s also a 5-star-rated stock, trading close to that 30% discount. You know me. In my mind, I kind of look at Verizon and AT&T both very similar. So as far as an investor, both of them trading at a similar discount, both having kind of that narrow economic moat. I think it’s a matter of just taking your pick as far as which one you prefer over the other.
Dziubinski: Got it. Well, thanks for your time this morning, Dave. Viewers interested in researching any of the stocks that Dave talked about today can visit Morningstar.com for more analysis. Dave and I will be back live next Monday at 9 a.m. Eastern, 8 a.m. Central. In the meantime, please like this video and subscribe to Morningstar’s channel. Have a great week.
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