Stock Market Outlook: Finding Opportunity Beyond Mega-Caps

During the third quarter, broad market indexes continued their march higher. Quarter to date through Sept. 25, the Morningstar US Market Index has risen 7.8%, which places it in the green, with a year-to-date return of 3.8%. By aggregating the fair value estimates of the 825 stocks in our North American coverage, we see the broad equity market trading near fair value. However, the broad market-cap-weighted valuation is upwardly skewed by several significantly overvalued mega-cap stocks. Still, pockets of undervaluation remain. Across our North American coverage, we rate 36% with 4 or 5 stars. Analyzing our coverage with the Morningstar Style Box reveals that the greatest number of undervalued stocks reside in the mid-cap category and that the highest percentage of 4 or 5 stars are found in the small-cap space.

• Energy is by far the most undervalued in our coverage, as almost 70% of the stocks trade at 4 or 5 stars.
• While prices retreated in September, technology remains the most overvalued sector in our coverage, as there is only one 5-star-rated stock and 14 4-star stocks, accounting for only 15% of our coverage.
• The greatest number of undervalued stocks resides in the mid-cap space, accounting for 36% of our mid-cap coverage. Of our small-cap stock coverage, we rate 50% with 4 or 5 stars.

Broad Equity Market Trading at Fair Value; Over One Third of Our U.S. Coverage Remains Undervalued - source: Morningstar