The Best Types of Stocks to Buy in Today’s Fully Valued Market

Susan Dziubinski: First, Dave, recap January for viewers. How did the market perform, and what styles and sectors drove those returns?

David Sekera: January was actually just a very solid month. The Morningstar US Market Index was up 1.3% for the month. Now, interestingly, when we look at the performance here, driven by category, is really driven by, you know, core stocks. So when you take a look at our core segment of the index, it includes Meta META, Broadcam—Broadcom AVGO, excuse me—Procter & Gamble PG, and a couple of other large-cap stocks that did very well during the month.

So, for example, Meta was up 10% in January, Broadcom up 6%. Procter & Gamble up 7%. So those, because of the size of their market cap, did skew the core sector higher. When I look at value stocks are up a quarter percent, nothing stellar. But again, at least, you know, to the upside. And interestingly, growth stocks, I don’t think a lot of people would expect, were actually down a half a percent in January.

The two biggest drawdowns here were Apple AAPL and Tesla TSLA. Apple is down 4%, Tesla down 25%. So those two stocks did skew that part of the market down. And when we look by market cap, you know, large caps were the winner. They’re up 2.5%. Mid-cap stocks are up 1.2%, and small-cap stocks down 3.0%.

Dziubinski: Now that we’re we’ve headed into February, does the market look fairly valued?

Sekera: It does. In fact, if you look at a composite of where the market is trading, all of the stocks that we cover versus the market-weighted value of our intrinsic valuations, the market right now is trading exactly right at 1.0. So right at our price/fair value metric.

Dziubinski: Which sectors in particular look overpriced today, Dave?

Sekera: The first is going to be the tech sector. That’s now trading in the 9% premium to our fair value. They’re getting pretty far well into overvalued territory, in our view. Not necessarily the most overvalued it’s ever been in the past and could certainly get more overvalued in the short term, but it is an area that’s probably getting to be overextended at this point. Industrials is also slightly overvalued at a 4% premium to fair value, and consumer defensive also a little overvalued at a 2% premium.

Dziubinski: And then let’s look at the opposite side of the coin. Which sectors look undervalued?

Sekera: The first two are going to be communications and real estate. Those are both trading at a 12% discount. A lot of different opportunities that we see for investors in both of those areas. Basic materials has been struggling as well. That’s now at an 11% discount to fair value. A lot of interesting ideas that we’ve got there. And then lastly, energy and utilities are both trading in the 9% discount.

Dziubinski: And then let’s pivot over and look at the market by market cap. Small caps versus large caps. Do small caps still look like the better value today?

Sekera: They do. And with the drawdown in January, they’re getting to look even more attractive than they were, you know, coming into the month. So, yes, at the end of the day, small caps do remain the most undervalued part of the market. They trade at a 19% discount to fair value. And for a number of different reasons, I do think that they’re still set up to do well over the course of this year and into the next.

Dziubinski: And then let’s look at the market through value stocks versus core stocks versus growth stocks. How do valuations look?

Sekera: Value stocks still remain the most undervalued, according to our valuations. They trade at an 11% discount to fair value. [Growth] stocks getting a little overextended, now trading at a 4% premium, and then core stocks at a 1% premium.

Dziubinski: Given where valuations are at the start of February, how should investors be thinking about their stock portfolios today?

Sekera: Based on our valuations, I would say your overall equity weighting should be right at your targeted allocation. So, whatever your allocation is based on your risk profile between equity and fixed income, I’d be right at what those targets are. Right now, I don’t think there’s a reason to be either overweight or underweight equities at this point in time.

But I do think the opportunities really are to be able to manage within those different allocations and try and take advantage of where we do see some value today. By category, you know, I think being overweight value would be the right way to go. I’d probably underweight growth in order to be able to pay for it. And with core stocks being only a 1% premium, I think you could probably just market-weight that.

And then by capitalization, I would overweight small-cap stocks, probably have a slight modest overweight in mid-cap, and then to pay for that, I think you need to be a little underweight in the large-cap stocks. And then by sector, I would look to underweight tech and industrials, maybe a little underweight in consumer defensive as well, and use that to be able to overweight communications, real estate, basic materials, energy, and utilities.

This is an excerpt from the Feb. 5, 2024, episode of Monday Morning Markets with Morningstar’s Dave Sekera. Watch the full episode, “3 Stocks to Sell and 3 Stocks to Buy in February.” See a list of previous episodes here.