Dave Sekera: Taking the Market’s Temperature

Episode Summary

Executive Summary: Morningstar strategist Dave Saccara argues U.S. equities are only modestly undervalued overall, but leadership has shifted: growth and mega-cap tech are close to fair value while value, small caps, and select sectors like communications and parts of real estate remain cheaper. He also sees inflation easing, rates peaking, no recession in the base case, and better fixed-income opportunities as yields offer positive real returns.

Main Topics: Morningstar’s valuation framework vs. top-down market metrics (Priority: 5/5): Saccara explains that Morningstar uses a bottoms-up intrinsic value approach across 1,500+ stocks, contrasting it with top-down measures like CAPE and market-multiple targets that he считает less useful for long-term investing. Growth vs. value rotation (Priority: 5/5): He says value outperformed in 2022, growth led in 2023, and the market has likely become more balanced; growth is now near fair value while value still offers a larger margin of safety. Mega-cap concentration and market leadership (Priority: 4/5): The discussion centers on the dominance of the 'magnificent seven,' with the key point that concentration itself is not the problem; valuation and portfolio exposure are more important than index concentration alone. Sector and style opportunities (Priority: 5/5): Technology looks most overvalued after its rally, while communications remains the most undervalued sector, with traditional telecom and media names still cheap. Small caps also appear attractive relative to large caps. Macro outlook: inflation, recession, and rates (Priority: 5/5): Saccara expects inflation to continue cooling, the Fed to pause and then cut in 2024, the 10-year yield to peak near current levels, and the base case remains no recession despite elevated recession probability. Fixed income, credit, and capital allocation (Priority: 4/5): He argues higher bond yields now offer a better real return, high-yield spreads reflect lower recession fears, and management quality should be judged by how firms deploy free cash flow among growth, M&A, debt paydown, dividends, and buybacks. Real estate and housing (Priority: 4/5): Commercial office remains challenged, but other REIT areas—data centers, senior housing, Class A malls, and medical office—look attractive. Residential construction may improve as mortgage rates fall and affordability improves.

Key Arguments: Morningstar’s valuation work is bottoms-up and intrinsic-value driven, not based on market multiples or CAPE-like snapshots. The market is still slightly undervalued overall, but much less than earlier in the year; valuation gaps have narrowed as stocks rallied. Growth stocks, especially tech, have largely run up to fair value, while value still trades at a meaningful discount. Mega-cap concentration is not inherently dangerous; the key issue is whether investors are paying too much for the biggest names. Technology is the most overvalued sector now because AI enthusiasm may be getting ahead of near-term fundamental impact. Communications remains cheap because legacy telecom/media names still trade at depressed valuations despite improving industry structure. Small caps look relatively attractive because recession risk has eased and the economy has held up better than expected. Higher bond yields are now more compelling because they may offer positive real returns as inflation declines. Morningstar’s base case is no recession, with any downturn likely short and shallow if it occurs. Office real estate remains risky, but other property types tied to secular demand or recovering foot traffic offer opportunity.

Data Points: U.S. market vs. fair value: about a 5% discount - Morningstar composite valuation after the first-half rally U.S. market vs. fair value at start of year: about a 16% discount - Composite valuation at the beginning of the year Morningstar coverage: over 1,500 stocks globally - Size of equity research universe used for composite valuation U.S.-listed coverage: over 700 stocks - Portion of Morningstar coverage trading on U.S. exchanges Narrow economic moat horizon: 10 years - Companies with a narrow moat are expected to sustain excess returns for roughly a decade Wide economic moat horizon: 20 years or more - Companies with a wide moat are expected to sustain excess returns for 20+ years Technology sector valuation: 7% to 10% premium - Most overvalued sector after the rally Communications sector valuation: most undervalued sector - Sector Morningstar sees as cheapest currently Value stocks valuation: about 15% discount to fair value - Current valuation gap cited as a source of margin of safety Growth stocks valuation: close to fairly valued - Growth category after strong first-half performance Magnificent Seven market contribution: two-thirds to three-quarters of market return this year - Illustrating concentration in index performance Valuation stars for Magnificent Seven at start of year: 6 of 7 were 4- or 5-star - Most were judged undervalued before the rally Current star ratings for Magnificent Seven: 1 undervalued, 4 fairly valued, 2 overvalued - After the rally, most have moved toward or above fair value Value stocks valuation in relative terms: about 15% discount - Used to justify overweighting value over growth Tech sector relative to fair value in 2022: overvalued - Reason Morningstar favored value during the 2022 selloff U.S. high-yield credit spread at start of year: about 480 bps - Morningstar U.S. high-yield index spread Current U.S. high-yield credit spread: about 410 bps - Spread narrowed as recession fears eased Recession probability estimate: 30% - Preston Caldwell’s current recession probability reference WTI long-term oil forecast: $55 per barrel - Morningstar energy team’s long-term assumption Current WTI price mentioned: around $70 per barrel - Reference point for energy and inflation outlook Federal funds rate current level: about 5% - Current policy rate reference during discussion 10-year Treasury yield current level: around 4% - Seen as near peak or close to peak 10-year Treasury yield forecast for 2024: 3.5% average - Morningstar forecast 10-year Treasury yield forecast for 2025: 2.5% average - Morningstar forecast Inflation forecast: 2% year-over-year by end of this year - Morningstar economics team projection Inflation forecast next year and thereafter: slightly below 2% - Morningstar economics team projection Fed cut timing: February of next year - Expected start of rate cuts Commercial real estate focus: urban office space most at risk - Segment still expected to see downward valuation adjustments

Pivotal Quotes: "the market's still at a slight discount, trading at about a 5% discount to a composite of our fair values" — Dave Saccara: Current overall market valuation "the growth category is really starting to approach fair value" — Dave Saccara: Explaining why Morningstar is becoming less constructive on growth stocks "we do think that the value area ... has a better margin of safety" — Dave Saccara: Rationale for overweighting value relative to growth

Implications: Listeners should expect a more selective market: less upside from crowded mega-cap growth, better prospects in undervalued value, small caps, communications, and some REITs. Bonds look more attractive as inflation cools and yields normalize, while recession risk remains present but not central to the base case.