Equities had a good start to the year, seeing some impressive increases. That changed mid-March due to the banking sector. But by the end of the quarter, equity markets rallied again.
It is on a valuation basis that the equities story takes shape. Every sector across Morningstar’s coverage universe continues to trade below its fair value estimate.
An unusual, but welcome scenario for investors.
Sectors such as industrials are trading close to their fair value estimates, while others, like consumer cyclicals and communications, look particularly attractive.
Based on Morningstar’s valuations, the group continues to see the best positioning for long-term investors in a ‘barbell- shaped portfolio’: overweight value and growth stocks, which are 15% and 16% undervalued, respectively, and underweight core stocks, which are trading closer to fair value.
By market capitalisation, small-cap stocks remain the most undervalued on a 25% discount to fair value. And the most undervalued category in the Morningstar Style Box is small-cap value, trading at an almost 40% discount to fair value.
Whereas the large and mid-cap categories remain at a discount similar to the broader market.
Defensive sectors slipped below fair value but are fully valued on a relative basis as compared with the rest of the market.
Within economically sensitive sectors, energy was the worst performer, yet ironically the most overvalued. Communication services fell slightly more than the market, but remains a highly undervalued sector – trading at a 37% discount to fair value.
The most notable move among the cyclical sectors was real estate, which became even more undervalued, and is now trading at a 15% discount to fair value.
The conclusion is therefore simple: for investors looking for a bargain, there are many to be found.
Although one big proviso is that like any market opportunity, confidence is key. And for the market to achieve the hoped for gains, investors will need to be persuaded that the economy will be in a better place by the start of next year.
All the signs, thus far, are that it will.