3 Stocks to Buy if the Economy Stalls—and 3 Stocks to Buy if It Doesn’t

Susan Dziubinski: Hello, and welcome to The Morning Filter. I’m Susan Dziubinski with Morningstar. Every Monday morning, I talk with Morningstar Research Services’ chief US market strategist Dave Sekera about what investors should have on their radars, some new Morningstar research, and a few stock picks or pans for the week ahead. Good morning, Dave, and happy New Year. We have a quiet week ahead in terms of key economic reports except for some payroll numbers later this week, right?

David Sekera: Good morning, Susan. Happy New Year to you as well and to all of our viewers out there. This week is relatively quiet. I know the ISM PMI [ISM Manufacturing Purchasing Managers Index] numbers are coming out this week as well, but realistically, I think the market and myself are really just going to be focused on the unemployment and the nonfarm payroll numbers. Taking a look at the consensus here, I think the consensus for payrolls is 154,000. That would be a slowdown from what was put out last month, but I think 150,000-ish, it’s an average number that we used to see prepandemic. And in my opinion, I think that would really put us in line with our expectation for a slowing rate of economic growth but no recession.

Taking a look at a consensus here for unemployment, that’s supposed to remain steady at 4.2%, and then the consensus for average hourly earnings is a 4.0% increase on a year-over-year basis, which I actually think that would be a positive for the market and really for the economy as well. Realistically, what I really want to see is increases in wages, especially for lower-income households.

Dziubinski: We have the Fed meeting at the end of January, so of course we’re going to see additional inflation and economic data before then. Given that, how important will this week’s payroll numbers be in the grand scheme of things?

Sekera: I think pretty important. The next FOMC meeting is going to be Jan. 28 and 29. Taking a look at the numbers right now, I think the market-implied probability is 90% that the Fed will end up holding rates steady at the current 4.25 to 4.5% range. The Fed has cut 100 basis points in total since last September. Of course, they started off with that 50-basis-point cut that was then followed by two 25-basis-point cuts. And I know our US economics team is forecasting that the Fed skips here in January and uses that pause to evaluate additional incoming data. But then our projection is that the Fed will cut again at the following meeting on March 18 and 19. The market implied probability for that is really just a coin flip right now at about 50/50. And then looking forward, the Morningstar US economics team is still expecting inflation to moderate throughout 2025, so they expect a number of additional cuts coming throughout the rest of this year.

Dziubinski: It’s also a quiet week on the earnings front, though we do have a company reporting this week that’s been a pick of yours and that’s Constellation Brands STZ. How does the stock look heading into earnings?

Sekera: The stock looks pretty attractive to us. It’s a 4-star-rated stock and trades at about a 24% discount to our fair value. It’s a company with a wide economic moat. That moat, of course, being tied to its distribution of the Corona and Modelo brands, both very well known here in the US, and I believe beer makes up about 80% of the company’s revenue. And then its secondary moat source is going to be its cost advantage. It’s a stock we rate with the Medium Uncertainty. And as you’ve noted, I think we’ve talked about this one quite a bit over the past couple of years and always put this one on the list of one to watch to be able to buy on pullbacks, and it looks like we’ve gotten that pullback.

Dziubinski: Constellation Brands stock finished 2024 in the red. What might it take for things to begin to turn around?

Sekera: I don’t think it’s necessarily a problem with the fundamentals. In fact, after last quarter’s earnings, our analyst bumped up our fair value by 4% to $291 a share. The beer performance, which is 80% of the business, was solid. The wine and spirits businesses were a little on the weaker side, but our analyst is still projecting, I think, $13.70 per share for this fiscal year. On average, we’re looking for, call it 10% to 11% earnings growth over the five-year forecast period. The stock trades I think at about 16 times our 2025 projected earnings. So I think everything is fine from a fundamental point of view.

I think right now the big concern in the market is if President Trump puts tariffs on imports from products coming from Mexico, which of course is where their beer is made. And then the concern there is how much of a negative impact could that have on its sales? This quarter, I’m really listening to hear to see if management’s going to say anything about what contingency plans they may have to put in place, if that comes to pass, what their ability is, at least in their view, to be able to pass through those higher costs to consumers, and or any additional cost-cutting plans that they may have to put in place in order to try and hold their margins.

Dziubinski: Let’s take a question from a viewer. Kenneth owns a few stocks he’d like your opinion about, and they’re Western Union WU, Volkswagen, and Medtronic MDT. And Kenneth is asking specifically about the ability of these stocks to rise in price over the next 18 months. So, start with answering that, Dave.

Sekera: It’s one of those things. It’s impossible to know what the market itself is going to do in the short term over a 12- to 18-month period. We certainly know how you may want to be positioned based on valuations, but there’s always a lot of technical and other exogenous factors that can move the market around as well as individual stocks. As long-term investors, we still always look to be able to position investors in those stocks that we think trade at a significant margin of safety from their intrinsic valuation. That way, it provides both the upside potential if the market rallies, and that, of course, helps cushion to the downside if the market retreats.

Dziubinski: Dave, then let’s give viewers and Kenneth a quick hit on what Morningstar thinks today about Western Union, Volkswagen, and Medtronic.

Sekera: I really haven’t paid that much of attention to Western Union. It’s a very small-cap stock. I think it’s only a $3.5 billion market cap, but it is rated 5 stars right now, trades at a 38% discount to our fair value, and has almost a 9% dividend yield. It’s a company we rate with a narrow economic moat. Has a Medium Uncertainty on the stock rating. And, of course, I think most people know this company. They make their money charging fees when people wire money back and forth, and a significant portion of their earnings does come from people wiring money from the US to the emerging markets. So, I think in the market right now, there’s just a lot of concern about what changes to immigration policy could do to this company in the short term.

Volkswagen, I’ll admit as the US strategist, I don’t pay that much attention to our European coverage. This is a 5-star-rated stock. Trades at just a huge discount to our fair value. On the screen, it shows up with an 11% dividend yield, but I just don’t know how safe that dividend yield is. So, that’s one where I would say you really need to take a look at our research there and really do some deeper dives on this one. Personally, just in general, I just don’t like investing in the auto manufacturers. I think there’s just too much competition in that individual space.

And then lastly, Medtronic, we’ve talked about Medtronic a number of times over the past year, if not necessarily the past two years, why we think that stock looks undervalued and is attractive to us. It’s a 4-star-rated stock, 28% discount, narrow economic moat. I’d say for these three stocks, and of course, all of our stock coverage, go to Morningstar.com or whichever Morningstar platform you use to read and learn more about these companies and our valuations.

Dziubinski: Let’s move on to talk about some new research. You’re in the middle of putting the finishing touches on your 2025 market outlook, which will publish on Morningstar.com later this week. Now, you’ve given me a sneak preview and your title and your outlook, “Markets Price to Perfection, but Will It Last?” What do you mean by that, Dave?

Sekera: The market is trading a little bit above our fair value estimates right now, so that’s the “price to perfection part” of the title. But trying to think about the “will it last” part, a lot of my concerns right now is that the tailwinds that had been pushing the stocks higher, the market in general higher, in 2024 have begun to fade. Specifically, the rate of easing monetary policy is starting to slow. We’re expecting a skip here in January, and then only a few more cuts over the course of the rest of this year.

When I take a look at long-term interest rates, the yield on the 10-year is actually back up. It’s back to its 52-week high and inflation has been pretty sticky the past couple of months. And of course, many of the AI stocks, which powered the market last year, are at the point where they’re if not fully valued, we do think that they are getting to be overvalued. So, one of the real big questions in my mind thinking about this year and what stocks might do over the course of the year is whether or not the economy can continue to keep running at a faster economic growth rate than what we expect like we’ve seen the past couple of quarters.

Dziubinski: Let’s get into market valuations. You mentioned that the stocks heading into the new year, look, is it fairly valued or are they really overvalued?

Sekera: It’s right in between. So they’re still trading at a slight premium at about a 2% to 3% premium to our fair value. So, not nearly as overvalued as it was getting in early December when it was trading at a 5% to 6% premium to fair value. That’s the point where it really does trip into the area where we do think the market’s becoming overvalued. So, here, maybe a little overextended in the short term, but not nearly as overvalued as where it was just a couple of weeks ago before the little bit of a selloff we’ve had.

Dziubinski: Let’s look at the market through the lens of market capitalization, and small-cap stocks are still more undervalued than large-cap stocks, and that’s been the case for quite a while, right?

Sekera: That’s definitely been the case for a while according to our valuations. Although I’d note that we did start to see that start to converge last fall with small caps starting to outperform in some selected areas. So taking a look at our valuations at year-end, small caps were still trading at a large discount, a 16% discount to fair value, whereas large-cap stocks have sold off a bit over the past couple of weeks, but they’re still at a 4% premium.

Dziubinski: Let’s parse things now by growth stocks versus value stocks versus core stocks. How do valuations look?

Sekera: This is where we’re really seeing the biggest discrepancy in our valuations as compared to the market. So, core stocks are relatively close to our fair values, whereas value stocks are trading at a 8% discount, looking pretty attractive in my mind there. Whereas growth stocks are still trading at a really high premium, not nearly as high of a premium as they were before this little bit of a selloff, but still at a 18% premium.

Dziubinski: Given your market outlook, Dave, how should investors be thinking about their portfolios at the start of 2025, particularly when it comes to investment style and market cap?

Sekera: I’m still very cautiously at a market-weight recommendation with investors. Should be at their targeted allocations, but within those allocations, we’d look to overweight the value category, market-weight core and underweight growth. And then by capitalization, still remain overweight. Those small-cap stocks, market-weight mid-cap, and underweight large-cap stocks. And I’d also note, too, looking at the fixed-income market with the backup and the 10-year Treasury getting to 4.6%, I think that looks pretty attractive here. Although in the fixed-income market, I’d still steer clear of corporate bonds, both investment-grade and high-yield. I just don’t think you’re getting paid enough for the risk in those specific markets.

Dziubinski: It’s time for the stock picks portion of our program. This week, you’ve brought us some undervalued stocks with economic moats, half of which are economically sensitive and half of which are more defensive. Why the split this week, Dave?

Sekera: I’m really taking a bit of a barbell approach to valuations and positioning right now. I just have to admit, in my opinion, I think the market outlook is just especially cloudy right now. Now, I still think you should be at that market weight in your equity at your targeted allocations, but personally I just remain more nervous now than I did really any other time in 2024.

Over the course of last year, we just always continued noting that the tailwinds definitely were overpowering the amount of headwinds. Specifically, the Fed was easing monetary policy. For much of the year, long-term interest rates were declining. The rate of economic growth was coming in much stronger than anyone expected, ourselves included. And inflation had been on a downward trend for much of the year, and of course, artificial intelligence was growing at an accelerating rate.

At this point, I think a lot of these tailwinds have really slowed. So looking forward, when I’m thinking about looking at individual stock picks, I still want exposure to growth stocks just in case economic growth does continue to come out higher than expected. But having said that, if economic growth slows and we start having more of the headwinds as the tailwinds fade, I think you’ll be very happy having some of these defensive stocks in your portfolio giving you that good diversification between growth and value. So, in this case, I’m taking that barbell approach.

Dziubinski: Remind viewers, Dave, what are Morningstar’s expectations in terms of the economy in 2025?

Sekera: We expect the rate of economic growth to slow. I took a look at our numbers here. Our Morningstar US economics team is forecasting 2.0%, actually 2.2% growth rate for this past quarter, for the fourth quarter of 2024. That’s a reduction from the 2.8% that was posted in the third quarter. That is then slowing once again to 1.7% here in the first quarter of 2025, and slowing again to 1.5% in the second quarter of 2025. And then looking for that gradual reacceleration in the economy in the second half of the year.

Dziubinski: Let’s get onto the picks, beginning with a couple of large companies. Your first stock pick is AMD [Advanced Micro Devices] AMD. First, tell us if AMD is an economically sensitive or a defensive idea, and then run through the key stats on it.

Sekera: AMD is in the technology sector. Specifically, they sell a lot of semiconductors used for servers, PCs, things that are going to be much more sensitive to the economy, so I’ll definitely put that in the economically sensitive category. It’s a 4-star-rated stock at a 22% discount to our fair value, although I’d note that it does not pay a dividend. So I think this might be one that dividend investors might want to steer clear of, but it’s a company with a narrow economic moat and a High Uncertainty rating on the stock.

Dziubinski: AMD stock did pretty well in 2023, riding a bit of an AI wave, but then it peaked in early 2024 and has since pulled back quite a bit. What drove that turn in sentiment?

Sekera: AMD, as you noted, it surged in 2023 and early 2024. In fact, looking at the charts here, went from a 5-star-rated stock in November of 2022, all the way up to the point that it was a 2-star-rated stock. In fact, it’s almost a 1-star-rated stock in early 2024 when it peaked.

The thesis here is that over the long term, we think AMD will eventually be the number-two player in making semiconductors and GPUs for artificial intelligence behind Nvidia NVDA, which will be the number-one player for quite a while. But I think the market just overestimated AMD’s ability to catch up to Nvidia in the short term. Nvidia, of course, still has a significant lead over AMD. Certainly has that first-mover advantage.

I think in the second half of 2024, the market recognized that, and with the valuation just being as high as it was, the stock has fallen 10% over the course of 2024. But I think realistically, you need to look at what it did intrayear as an indication of just how overvalued that stock had gotten. So, it’s actually down over 40% from its March 2024 high.

Dziubinski: Go into Morningstar’s long-term thesis on the company, Dave, a little more. We really do think that AMD can compete with Nvidia?

Sekera: We do, and reading through our write-up here, there are a lot of technical reasons as to why, but the short answer here is yes, we do think that AMD will be the number-two player in AI and graphic processor units for artificial intelligence. But over the next couple of years, we still continue to expect Nvidia to capture what we consider to be the lion’s share of the AI hardware market. But we do think that over time, a lot of the vendors for artificial intelligence, a lot of the customers will seek alternatives to Nvidia really specifically to support competition in that market and help keep Nvidia’s dominance in check.

Dziubinski: Your second pick this week is Verizon VZ. So is this one a defensive or an economically sensitive pick, Dave?

Sekera: I consider it to be relatively defensive. In my opinion, even if we do have an economic downturn, I still expect customers to pay their cellphone bills and probably pay their cellphone bills ahead of some of their other bills. And taking a look at the stock, I think that this is one that should hold up pretty well pretty much in any kind of market.

Dziubinski: So, run through the key stats on this one.

Sekera: Sure. It’s a 4-star-rated stock, 24% discount to fair value, nice healthy dividend yield at 6.7%, company we rate with a narrow economic moat and a stock with a Medium Uncertainty rating.

Dziubinski: Verizon’s stock performance in 2024 pretty significantly lagged that of its competitors AT&T T and T-Mobile TMUS. Why was that?

Sekera: I think I need to go back even before 2024. We started talking about the wireless industry I think in mid-2023. And we noted at that point in time, our long-term investment thesis was that the wireless business over time would start to act more and more like an oligopoly. We thought that they would compete less on price and that would then allow margins to rise over time. So in mid-2023, both AT&T and Verizon were trading at pretty large margins of safety, both paying very large dividend yields. But at that point in time, when I spoke to Mike Hodel, he’s the sector director, he preferred AT&T over Verizon.

Taking a look at these two stocks, year to date, AT&T phenomenal year up 35%, whereas you mentioned Verizon’s been lagging. It’s only up 7%. So I reached back out to Mike again at the end of last week. In his opinion, he’d think it’s just a matter that the market appears to prefer AT&T’s strategy of building out its own fiber network, whereas Verizon has been buying a network instead. And then he also noted AT&T has delivered slightly better revenue and wireless customer growth over the past couple of quarters as well.

Dziubinski: Why is Verizon stock Morningstar’s choice today rather than AT&T or T-Mobile? Is it strictly valuation-based?

Sekera: It is really just a matter of valuation. AT&T, is still slightly attractive at a 9.0% discount, 4.9% dividend yield. But, again, taking a look at a Verizon, it’s at a 24% discount. So, I think that’s a much larger margin of safety plus the higher dividend yield because it does have that lower valuation. But then taking a look at T-Mobile, that one’s actually trading at a 12% premium, so that one’s getting to be pretty pricey in our view. And with as high of a valuation as it’s trading, it only has a 1.6% dividend yield.

Dziubinski: All right. So next up, your next two picks are a couple of mid-cap ideas. The first is Kraft Heinz KHC. Walk us through the metrics on this one and tell us whether the stock is a defensive or an economically sensitive play.

Sekera: A 5-star-rated stock, 45% discount, 5.25% dividend yield, narrow economic moat, Medium Uncertainty. For a company that’s in the consumer packaged goods, specifically the food category, definitely falls into the defensive category, in my mind.

Dziubinski: Morningstar upgraded its economic moat rating on Kraft Heinz last June. Why and what’s our take on the company’s long-term perspective?

Sekera: When Kraft was originally bought by 3G Partners whatever year it was, years and years ago, 3G really overemphasized short-term profitability over building long-term economic value. Initially, that looked like it worked, but then over the past number of years, performance started to drop off thereafter.

So, realistically, in our view, we think over the past five years, Kraft has really gone back, revamped its strategy, gone back to focusing on building long-term value by doing things like reinvesting more in its brands, has much more improved category management, better efficiencies. We think the company is back on the right track. We think that the changes it’s made has strengthened its intangible assets, such as its brands. So, that’s led to the moat increase. It’s a narrow economic moat, plus it’s also strengthened its cost structure. We think it’s in a better competitive position going forward.

Dziubinski: Kraft Heinz stock was down about 12% in 2024. What might it take for the stock to turn around?

Sekera: I think the market really wants to see a margin expansion before they’re going to give the company too much more credit for it. When I think about what’s going on in the food industry over the past two years with inflation as high as it’s been, lower-income households, and to some degree, even middle-income households have been under a lot of pressure as wages just failed to keep up with inflation over the past two years. That did take a toll on the branded food companies.

From our view, I think this is a bit of a normalization play. We think that over time, as inflation moderates, and wages catch up, we do look for a top line to rebound here. And then from a margin perspective, we expect that over time, the company will be able to realize better operating margins from its cost-cutting programs.

Looking at the numbers here, when I opened up the model, prepandemic, the average operating margin was 22.6%. We’re forecasting the margin to expand to 20.7% from 20.3% last year, and ongoing gradual improvement to 21.9% by 2029. Still below where it was on average prepandemic, but the stock’s trading I think at about 16 times our 2024 earnings estimates, and that drops all the way down to about 10 times our 2025 earnings estimates.

Dziubinski: Your second mid-cap pick is economically sensitive. It’s Devon Energy DVN. Give us the highlights.

Sekera: Sure. It’s a 5-star rated stock, trades at about a 29% discount to fair value, 4.25% dividend yield. Although I do have to note that that dividend yield is really based on both a combination of a fixed and a variable dividend. So, that’s not necessarily set in stone as the capital allocation strategy of the company is to return 70% of free cash flow to shareholders. So, that will vary depending on their free-cash-flow performance. But we rate the company with a narrow economic moat. The stock has a Medium Uncertainty rating, so it looks pretty attractive to us.

Dziubinski: Why is Devon one among Morningstar’s favorites in the energy sector today?

Sekera: It’s a combination of the valuation as it does trade at a pretty good margin of safety from fair value. But I know our analyst team still continues to view the company as a steady low-cost provider whose assets are on the lower end of the US shale cost curve.

Dziubinski: Let’s wrap up with a couple of small-cap stock picks. The first is FMC FMC. Is this an economically sensitive or a defensive pick, Dave?

Sekera: The answer is yes. It is in the basic-materials sector, so technically it is much more of a cyclical play, but the company itself sells crop-protection chemicals. In my mind, I do think of it really being much more of a defensive play. I don’t think the risks are as tied as much to the economy as they are to other variables such as the weather and commodity prices.

Dziubinski: All right. So run through some of the key stats on FMC.

Sekera: It’s a 5-star-rated stock, trades at over a 50% discount to fair value, 4.8% dividend yield. A company we rate with a narrow economic moat, and the stock has a High Uncertainty rating.

Dziubinski: FMC stock fell about 18% just in December, and it’s 65% off its highs from 2022. What’s been going on?

Sekera: I think I need to parse this one out really to two parts of the timeline in this story. As you mentioned, it’s off a lot from its highs in 2022 but then it did take a bit of a selloff here in December. So, you have to remember the backstory with this company. Back in 2021 and 2022, we had all of the supply chain disruptions that led to customers buying and holding excess inventory during those years. That then pulled forward a lot of future sales and revenue, but the stock ran way too high in 2022 and in early 2023. So, the stock has sold off a lot since then because the market was pricing in too much of that growth lasting for too long. Now in 2023, as the supply chain bottlenecks were opening back up, the customers then used up that excess inventory. That put a lot of pressure on revenue and earnings in 2023 and the first half of 2024, so now the stock appears to have fallen because people are pricing in those much lower growth rates.

Now as far as this recent selloff in December, I did reach out to Seth Goldstein at the end of last week. He’s the equity analyst who covers this stock. And in his view, he thinks it’s a couple of things. One, he thinks that there’s been poor weather in Brazil that’s delaying a recovery in sales here in the short term. But he also noted too that FMC does have a relatively high debt load. So, if we have fewer cuts by the Federal Reserve this year, that’s caused the stock here to fall more than some of the other peers of this company, which have lower debt amounts. And he also noted that another analyst from a different research provider recently downgraded their valuation a couple of weeks ago. So, I think that’s all playing on the stock here in the short term. Having said all that, Seth just doesn’t see a reason to change his long-term forecast and investment thesis. In his opinion, he thinks the current price is a pretty attractive opportunity.

Dziubinski: Dave, tell us a little bit more about what Morningstar’s long-term thesis is on FMC.

Sekera: That near-term thesis on FMC was that that inventory destocking was a temporary headwind. And of course, once that ended, the company’s sales and profits would bounce back in the second half of 2024 and that we are projecting much larger growth in 2025. And to some degree, the investment thesis does look like it’s playing out. We have the risk of weather in Brazil. But when we take a look at the results here, last quarter’s earnings reports, they beat the Street estimates on both the top and the bottom line. Adjusted EBITDA, for example, was up 15% year over year. And looking forward at that point in time, management guided to a 19% increase in revenue for the fourth quarter, with at least half of that growth coming from new products. That tells us FMC’s new products, we’re not necessarily cannibalizing its existing products, but also driving incremental growth. So, again, we haven’t changed our long-term forecast, which is really what the big difference is between our view on valuation versus where it’s currently trading in the marketplace.

Dziubinski: Your last pick this week is Sealed Air SEE. Is this a defensive or economically sensitive pick, and what are some of the highlights here?

Sekera: Sealed Air falls in the consumer cyclical category, so it’s definitely economically sensitive. It’s a 4-star-rated stock, 38% discount to fair value, 2.4% dividend yield, a company we rate with a narrow economic moat, although the stock does have a High Uncertainty Rating.

Dziubinski: Sealed Air stock has gone nowhere during the past year, year and a half. So what’s the market missing on this one?

Sekera: Again, this is one of these ones where I think the pandemic had a very large impact in the company’s underlying business, and the market’s just had a very difficult time really understanding the long-term intrinsic valuation. For those of you that don’t know, the company Sealed Air sells flexible resin packaging, protective shipping materials, integrated packaging systems. The stock had ramped higher in 2021. Customers saw a big increase in demand for their food packaging, a big shift in sales to goods away from services as the pandemic was still in play at that point in time. And, of course, we also then had a lot of shipping bottlenecks, so a lot of customers overordered. And then when we got to 2022 and 2023, the results were then under a lot of pressure. Customers used up that excess inventory. We saw a big shift in consumer spending back to services and away from goods.

I think a lot of that really played havoc with how this stock has traded in the marketplace. Looking forward, we’re only looking for relatively modest growth. I think over our five-year forecast period, we’re only looking for a 2.4% compound annual growth rate. But the big differentiation here between our forecast and the market view is that in this much more stabilized environment going forward, we project that the operating margins should be able to expand and in fact, we’re looking for them to grow to an average of about 16% over the next five years.

Dziubinski: Thanks for your time this morning, Dave. Viewers who’d like more information about any of the stocks they’ve talked about today can visit Morningstar.com for more details. We hope you’ll join us for the morning filter 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.

Got a question for Dave? Send it to themorningfilter@morningstar.com.