Morningstar - Q1 2023 - 19

TRENDS
Rare Discounts
After starting 2022 trading well above our
fair value estimates, the U.S. equity market has
dropped deep into undervalued territory.
As of Dec. 27, 2022, we calculated that the market
was trading at a price/fair value of 0.84,
representing a 16% discount to our fair value
estimates. This is based on a composite of our
intrinsic valuations on more than 700 stocks
under coverage by Morningstar's equity research
group that trade on U.S. exchanges.
Tightening monetary policy, a weak economy,
high inflation, and rising interest rates have
taken a toll on valuations. While the near-term
outlook remains challenging, according to
our long-term intrinsic valuations, the market is
trading deep into rarely seen undervalued
territory. Since the end of 2010, the market has
traded at or below the current discount only
5% of the time.
All
0.84
0.84
0.84
0.68
Style
Value
0.80
Before the emergence of the pandemic in early
2020, there had been only a few other
instances in which the market has traded at
0.81
0.79
0.60
such a discount to our valuations. In December
2018, the Federal Reserve had been
tightening monetary policy for a year, and markets
were pricing in a global growth scare. In
2011, markets were under pressure based on
concerns that contagion from the Greek
debt crisis would spread to other European
countries and prompt systemic defaults among
European banks.
While near-term conditions may pressure
earnings in the short term, at current valuations
we think the market has fallen more than
enough to incorporate those headwinds.
In our view, the market is overly pessimistic
regarding the long-term outlook.
Mid
0.89
0.89
0.89
0.72
Growth
According to our valuations, investors appear
best positioned in a barbell-shaped portfolio of
being overweight in the value and growth
categories and underweight in the core category.
0.80
0.80
Across capitalizations, large-cap and mid-cap
valuations are in line with the broad
0.80
0.75
U.S. Equity Market Has Rarely Traded at Such a Large Discount to Our
Intrinsic Valuations
1.2
All
1.1
1.0
0.9
0.8
0.7
2011
2014
Source: Morningstar. Data as of Dec. 27, 2022.
2017
2020
Source: Morningstar. Data as of Dec. 27, 2022.
0.84
0.84
U.S.
Equity Market
0.84
0.68
0.60
0.72
0.75
0.84
Valuations of Morningstar's Equity
Research Coverage by Style Box
Style
Value
0.80
0.81
0.79
Mid
0.89
0.89
0.89
Growth
0.80
0.80
0.80
market average, whereas small-cap stocks are
trading at an over 30% discount.
While we think the market is undervalued,
we expect the markets will remain
turbulent over the foreseeable future. Based
on our outlook that the economy will be
stagnant in the first half of 2023, we expect
volatility will remain high over the next
two quarters, but low valuations provide a
large margin of safety. An economic recovery
in the second half of 2023 should allow
equity markets to begin to recover toward our
long-term intrinsic valuations.
Dave Sekera, CFA, is chief U.S. market strategist at
Morningstar Research Services LLC.
Preston Caldwell is chief U.S. economist at Morningstar
Research Services LLC.
1.2
19
Price/Fair Value
Size
Small
Mid
Large
All
Size
Small
Mid
Large
All
https://www.morningstar.com/authors/1514/david-sekera https://www.morningstar.com/authors/2047/preston-caldwell
Morningstar - Q1 2023

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