Morningstar's chief US market strategist breaks down why the rotation into value stocks is bound to continue — and pinpoints 4 of the cheapest areas of the market with the most upside
- Value stocks surged on Monday after Pfizer announced it discovered an effective COVID-19 vaccine.
- Morningstar's Chief US Market Strategist Dave Sekera told Business Insider on Wednesday that the shift would continue in the near-term.
- Sekera also pinpointed the four most undervalued areas of the market.
- Visit Business Insider's homepage for more stories.
Value is back.
According to Dave Sekera, Morningstar's chief US market strategist, the 13-year drought for value stocks is over after investors began shifting into them Monday following Pfizer's announcement of its COVID-19 vaccine.
"It's about time," Sekera told Business Insider on Wednesday. "We're seeing a lot of the value stocks, especially in the small- and mid-cap space are outperforming. We expect that to continue over the near term."
Sekera said this is due in part to the fact that he expects GDP growth to be 4.7% in 2021, which will help stocks whose performance is tied to economic growth.
He added, however, that he expects value stocks to face some headwinds from a lack of adequate — by investors' standards — fiscal stimulus, despite the health of the economic recovery not needing robust stimulus.
Sekera predicts there will be a $500 billion package passed by Congress, less than the market is expecting.
But the headwinds that value stocks face aren't as strong as those faced by growth stocks — namely the type of mega-cap tech companies occupying the top spots in the S&P 500. He says the fact that they are so overvalued lessens their upside potential.
"If you look at our valuation on Apple, we're not trying to say that we think Apple stock is going down by whatever percent we think it's overvalued today," Sekera said.
"But we'd certainly see headwinds for any further price appreciation over the next two to three years on those stocks. So that's why we're looking at the value space as being the most attractive space for long-term investors today as opposed to growth," he added.
Overall, the market is currently overvalued by 4%, Sekera said, due to the high valuations of the top dozen companies.
4 of the most undervalued areas of the market
Another reason Sekera is bullish on a continued shift into value stocks is because they currently make up a disproportionate number of the firm's four- and five-star-rated stocks — which Sekera says is equivalent to their version of a buy rating.
This is especially true for small- and mid-cap value stocks, he said.
"What we've seen since the pandemic is that there's just been this huge dislocation and a big bifurcation in the markets between the winners and the losers, and we think over time with economic normalization that will start to shrink," Sekera said.
"We're expecting to see over time large-cap, and specifically large growth, facing the most headwind for valuation over time, and the small value, mid value having the most upside opportunity."
Those interested in adding exposure to small- and mid-cap value stocks might consider the Vanguard Small-Cap Value ETF (VBR) and the SPDR S&P 400 Mid Cap Value ETF (MDYV), respectively.
Sekera also pointed to two market sectors set to benefit from the movement to value.
The most undervalued, he said, is energy. The energy sector has suffered from plunging demand this year amid various forms of lockdown measures being taken around the world in an attempt to limit the spread of COVID-19.
"We have seen the energy sector pop a little bit with oil prices coming up over the last couple of days," Sekera said. "But even when you look at that, it's still the most undervalued we've ever seen in that sector going back to when we started covering stocks in 2002 — other than in March."
He added: "There's a lot of ways you can play in that sector today. Anywhere from large-cap, high-dividend-paying [earnings and profit] stocks, down to small [earnings and profit] companies, refiners, the services companies."
Sekera went on to say that he does not view a Biden presidency much of a headwind for energy — except for companies with fracking operations on federal land — and that he expects West Texas Intermediate Crude to sell for $55 a barrel over the mid-cycle.
Investors seeking exposure to the energy sector might consider the Fidelity MSCI Energy ETF (FENY).
Second, Sekera said that the real estate sector also remains vastly undervalued.
"Real estate is another one where we've seen a lot of pressure in there as people are trying to understand what the work from home environment will be going forward," he said.
"So that's one where we believe if you own Class A real estate, you're going to be fine for the long term. It's what they consider to be Class C and Class E real estate that will be under pressure."
The Vanguard Real Estate ETF (VNQ) offers exposure to the real estate sector.
This story was originally published by Morningstar.
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