Morningstar: Undervalued Stocks Are Becoming Rare

Thursday, 28 Mar 2013 08:32 AM

By John Morgan

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Domestic stocks are close to fair value, and investors should generally avoid index funds, exchange-traded funds and corporate bonds, suggests Morningstar's updated investment outlook.

Instead, investors should focus on individual stocks and themes that continue to have some upside, such as certain diversified industrials and natural gas stocks.

“Global equity markets continued their march upward in the first quarter, making undervalued stocks all that much more challenging to find,” Morningstar said.

Editor's Note: Unthinkable Haunts Investors: Evidence for Imminent 90% Stock Market Drop.

Overall, stocks are now trading at 97 percent of fair value, and U.S. stocks in particular are the most expensive, trading at 99 percent of fair value.

In such an environment, Morningstar said, investors are better off avoiding the overall market.

“Index funds and exchange-traded funds can be great for adding market exposure at lower costs, but if we're right that correlations are declining, we think investors will face better risk/return opportunities buying strong businesses that are undervalued.”

Morningstar also recommended investors be cautious about basic material and industrial stocks that have high exposure to Europe, given the troubled eurozone economy.

On the overvalued side, the publisher listed consumer defensive and real estate stocks. In particular, the consumer defensive sector “is just about as expensive as we have seen it in the past 10 years,” Morningstar said.

In addition, acceleration in economic growth could cause inflation, which would be bad for bonds.

“Although neither asset class looks particularly attractive based on valuations, we'd rather own stocks than bonds in this environment.”

FT Adviser echoed Morningstar’s concern about broad market valuations.

“All accepted methods of valuation show that the US stock market is some 50 percent above its historic mean value while bond markets, thanks to government intervention through quantitative easing, are all in bubble territory,” FT Adviser said.

Editor's Note: Unthinkable Haunts Investors: Evidence for Imminent 90% Stock Market Drop.

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