Stocks rebounded again, but the market is still undervalued

Even after rising more than 9% for US stocks in July, we still view the broad US stock market as undervalued, albeit less expensive than it was at the start of the quarter. According to a composite of valuations of nearly 700 stocks we cover that trade in the US, the market is now at an 11% discount to fair value.

Stock markets bottomed out in mid-June and then remained in range trading until mid-July as investors awaited the second quarter results. Profits were mixed with some notable losses causing some individual stocks to fall. But the quarterly results were generally not as bad as the market had expected.

More importantly, management teams did not throw in the towel in the second half of 2022. Company executives sought to dampen expectations but largely failed to deliver on the sentenceLu lowered their earnings forecast for the remainder of this year. With valuations already at low levels after the sell-off in late spring and early summer, this provided the market with enough confidence to begin reallocating capital to equity.

The main takeaways for the stock market today:

  • The US stock market is undervalued.
  • Increase value and growth stocks, reduce the underlying stocks.
  • Communication and cyclical sectors are the most attractive.
  • Headwinds are expected to start dissipating in the second half of 2022.
  • US stock market at 11% discount from fair value

    in our area Q3 OverviewWe noted that we thought the US stock markets were oversold and that since 2010, stocks have rarely traded at a significant discount to their intrinsic value. Indeed, in the middle of June, Stocks traded at their biggest discount to our long-term fundamental valuations since the outbreak of the pandemic in March 2020, and the growth scare that drove stocks lower in December 2018.

    On a longer historical time frame, the only other example in which our price/fair value metric has fallen below was the fall of 2011 amid fears of the Greek debt crisis spreading to other countries.

    After rallying in the second half of last month, as of July 29, the US stock market is trading at an 11% discount to our fair value.

    According to the Morningstar US Growth Index, growth stocks rose 14.2% in July, well outperforming the broader market. After these gains, these shares are now trading at a discount similar to value shares, while the underlying shares remain closer to fair value. As such, we continue to favor an iron-on portfolio split between excess value, growth stocks, and undercutting stocks.

    The Morningstar US Small Cap Index slightly outperformed in July, up 10.1%, with small cap stocks remaining the lowest by market capitalization. The performance of large and mid-cap stocks is in line with the broader market and both classes are undervalued.

    Look at cyclical and economically sensitive sectors for value

    Across our segment valuations, telecom services remain the lowest segment of the market to date, trading at a discount of 33% to fair value, followed by several cyclical segments that have suffered the brunt of the sell-off over the past few months. Defensive sectors, which have better kept their value on the downside, are somewhat exaggerated.

    It should be noted that more than half of the market value of the telecommunications sector is concentrated in Alphabet (The Google) and Meta platforms (dead). After earnings, we reduced Alphabet’s fair value by 6.1% to $169 to account for near-term weakness. However, we believe that the market is extrapolating this short-term weakness very far into the future. Even after downgrading our fair value estimate, the stock remains in the 4-star territory and trades at a 32% discount to our intrinsic valuation.

    We also lowered our valuation on Meta by 9.9% to $346 after poor second-quarter results and poor guidance. Similar to Alphabet, we think the market is over-pessimistic about the long-term Meta outlook. For example, based on the continued growth of Meta users, we believe that the impact of the corporate network remains intact, which is the basis of our broad trench rating. We anticipate further monetization of its Reels product along with an economic turnaround to re-grow the top-line into the low-to-mid range starting in the second half of 2023. Meta shares are trading at less than half of our base valuation, placing them deep in the 5 rating category. stars.

    Also of note in the telecom sector, we have lowered our rating on Twitter (TWTR) to $44 per share. We moved our fair value to Elon Musk’s purchase offer of $54.20 after the company accepted his offer to buy. But after he was submitted to close the deal, we revised our valuation, which is now based on the basic fundamentals of Twitter as a public company.

    The cyclical depreciation segment remains the second most undervalued segment, trading at a discount of 16% to fair value. With the economy weak in the first half of the year, this sector was the worst performing part of the market during that period. We believe that the best opportunities exist in those areas that can benefit from the normalization of consumer behavior. We expect spending to continue shifting back to services towards pre-pandemic levels and away from commodities, which have outperformed during the pandemic. For a more in-depth discussion of these opportunities, please see Spending Turns Back to Services; Here’s where to invest now.

    Random Selling During Deflation Leaves Extensive Stock Trench at a Discount

    During the worst selling, we noticed that in order to meet the redemptions, many portfolio managers resorted to selling what they could as opposed to what they wanted. Stocks of high-quality companies usually have a deeper pool of cash to sell than lower-quality names.

    As a result of this random selling, stocks with wide economic moats are trading at a greater discount than shares of companies with a narrow rating or no moat.

    We continue to see a great deal of value for long-term investors in the broad trench stock. In addition to their lower ratings, we also expect these companies to generally have more pricing power. As such, they should be able to pass on any cost increases to customers and be able to better maintain their margins, thus maintaining their valuations in an inflationary environment.

    prospects

    We still view the broad US stock market as undervalued. However, even at the current level, long-term investors should prepare and expect continued volatility over the next several months.

    In our 2022 forecast, we noted that there are several headwinds that the market will have to contend with this year. The two factors that the market will be watching closely now are economic recovery and moderate inflation. Over the next few months, the markets will be looking for signs that these challenges are beginning to recede. Any measures that the economy continues to weaken and/or that inflation will remain hotter for longer is likely to put renewed downward pressure on stocks.

    Based on our predictions, we believe that both of these headwinds should start to turn into tailwinds. For example, even after accounting for negative GDP reports in the first and second quarters, we still expect real GDP growth of 2% this year. We believe inflation has peaked and should start moderating from now on.

    “June [CPI] The report will almost certainly point to peak inflation, with food and energy prices set to fall sharply in next month’s report,” Morningstar’s chief US economist Preston Caldwell.

    We encourage market participants to stick to plans that balance long-term investment objectives and risk tolerance. These plans should allow for periodic rebalancing to increase equity provisions when valuations decline, but also reduce exposure when valuations become overly broad. Based on our view that the US stock market is undervalued, we believe that now is not the time to reduce equity exposure but to add wisely – especially in companies with wide economic moats.

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