US Stocks Undervalued but Tech Concentration Comes with Risks
TL/DR –
The US stock market is currently undervalued, implying higher than usual future returns, according to Morningstar analysts. The assessment comes after strong revenue and profit growth in the latest earnings season, and the market’s growing concentration in companies benefiting from the rapid growth in AI. However, this concentration in tech stocks brings with it the increased risk of lurching price movements driven by changes in investor sentiment.
US Stocks Appear Undervalued, However, with a Caveat
The latest earnings season saw a 13.1% increase in profits for large US companies, according to FactSet. Coupled with the US stock market’s increasing concentration in companies benefiting from AI growth, Morningstar analysts have boosted their estimates of the market’s fair value. Hence, Morningstar’s coverage of the average US company now suggests they are undervalued, indicating potentially high future returns.
However, the concentration in tech stocks – companies reliant on long-term future growth – has increased the risk of erratic price movements induced by short-term changes in investor sentiment.
Last week, despite the US market ending flat for the week, healthcare stocks rose by 3.6% while consumer cyclical stocks fell by 2.6%.
It must be noted that AI-benefiting firms Amazon AMZN and Tesla TSLA accounted for the entire sector’s decline, while most consumer cyclical stocks modestly increased. McDonalds MCD saw a 2.9% rise.
Diversification Difficulties Domestically and Internationally
Creating portfolio diversification presents challenges. While the US market is concentrated, diversification through international markets seems logical. However, last week highlighted that market concentration isn’t solely a US issue. Despite the numerous stocks and countries represented by emerging markets, a 2.4% decline in Taiwan Semiconductor TSM slowed the index’s growth.
This emphasizes the importance of understanding the fundamental drivers of asset classes for diversification in a market driven by dominant stocks, such as AI adoption. Although developed markets outside the US rose 1.7% last week, this was supported by a weakening US dollar. In such conditions, selective investing is crucial.
Federal Reserve Addressing Economic Data Backlog Following Government Shutdown
After the Federal government shutdown, the Bureau of Labor Statistics will begin addressing its backlog of delayed releases. Over 30 reports were delayed, many of which require timely data. As noted by Fed Chair Jerome Powell last month, policy has slowed in light of this uncertainty. The probability of a cut at the December meeting has fallen from 67% to 44%.
Nvidia Earnings in the Spotlight
Alongside tardy economic data, Nvidia’s NVDA results will be closely watched for insights into the AI ecosystem’s health. Unexpected strengths or weaknesses could shake equity markets. Stay updated on company and economic releases on Morningstar’s calendar.
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