Morningstar's top U.S. strategist sees headwinds fading — and says these 'high quality' stocks are oversold

Published Mon, Aug 8 20227:55 PM EDTUpdated Tue, Aug 9 20223:43 AM EDT

The S & P 500 's hot streak continued last week, logging a third straight week of gains after a 9.1% climb in July. Throw in a better-than-expected earnings season and some strong economic data, and the market might just be ready to move on from a dramatic first half. It's certainly a view echoed by Morningstar chief U.S. market strategist David Sekera. "Coming into the year, we thought the markets were overvalued. We highlighted four main headwinds that the market was going to contend with this year and those headwinds really have played out over the first half of the year," Sekera told CNBC "Squawk Box Asia" on Aug. 4. "But I think we are at the point where those headwinds are starting to dissipate. And in fact, by the end of the year, those headwinds could even start turning into tailwinds." Sekera acknowledged that inflation and the specter of further interest rate hikes by the U.S. Federal Reserve have continued to weigh on market sentiment, but sees pressures on both fronts easing. For example, he sees "pretty strong drops" in oil prices over the coming years, which could add to deflationary pressures. By 2026, the U.S. benchmark West Texas Intermediate crude and the global benchmark Brent crude could hit $55 and $60, respectively, based on Morningstar's projections. Brent futures traded around $94 a barrel on Monday, while U.S. West Texas Intermediate futures were around $88 a barrel. Moreover, the Fed is likely done with the bulk of its rate hikes this year, according to Sekera. Morningstar expects inflation to average 5.8% this year, and to fall to 2% next year. 'High quality' names that are oversold As such, Sekera believes that the market had overreacted in selling "high-quality" names at the peak of the market turmoil, with valuations having been "pushed down too far." " During the worst of the sell-off in the U.S., we saw a lot of indiscriminate selling, portfolio managers getting to the point where they just had to start selling what they could as opposed to what they wanted to," he said. As a result, several companies with four- and five-star Morningstar ratings now look oversold, according to the strategist. These stocks have a wide "economic moat" (or edge over competitors) and the best long-term advantages when compared to rivals, he said. Morningstar utilizes a star ranking system to help investors uncover stocks that are undervalued. The higher the discount to the stock's fair value, the higher the star rating and the more attractive the stock is. JPMorgan is one such stock, which Sekera said is trading at a 25% discount to its fair value. He also likes Honeywell and 3M in the industrials sector, adding that the stocks are trading at discounts of 18% and 23%, respectively. Sekera sees "a lot of opportunities" in the tech sector. Cybersecurity in particular, has been an "interesting" theme that has caught his attention, particularly in light of the war in Ukraine. His top picks in this space are the four-star rated Palo Alto and Zscaler , which he said are trading at discounts of 13% and 25% to their fair values, respectively. "Meanwhile, I think Okta is really interesting for investors looking for something that's going to be a little bit riskier but have more upside potential. That's one of our more undervalued stocks that's trading at about half of its fair value and rated five stars," he said. Rounding off his list is Starbucks , which is trading at a 16% discount to its fair value.