Morningstar's chief U.S. market strategist shares his outlook for the economy and ways to play the market turbulence ahead

Published Thu, Apr 27 20231:09 PM EDTUpdated Thu, Apr 27 20231:14 PM EDT

Many investors are bracing for more market choppiness ahead. But even in a turbulent environment, there are value opportunities for investors who look carefully, according to Dave Sekera, Morningstar's chief U.S. market strategist. "We think the stock market is undervalued," Sekera told CNBC during an interview at the Morningstar Investment Conference in Chicago. "However, I'd say at this point, the easy returns have already been made thus far this year, and I do see a rough road ahead for the next couple of quarters for the stock market in general." Morningstar's base case doesn't call for a recession this year, and anticipates a soft landing for the economy. If a downturn does hit, the investment research firm expects one that's short and shallow, Sekera said. Fears of a recession have consumed investors in recent months as the Federal Reserve trudges on with its most aggressive hiking cycle in decades in an attempt to tamp down inflation no matter the cost. At the same time, a banking crisis last month spooked many investors exposed to financial stocks, and lit concern that the turmoil could tilt the economy into a recession. Amid this backdrop, Sekera says now is not the time for investors to underweight equities. Morningstar believes the market now trades at a roughly 10% discount, with sectors like communications services and real estate trading well below their fair value. .SPX YTD mountain S & P 500 so far in 2023 Sekera expects near term volatility and choppiness over the next few months, but any sharp pullbacks could serve as good opportunities to pick up new stocks or overweight others. "In order to break through the top of that trading range, the market is going to actually want to start seeing leading economic indicators turn around and start moving back up," he said. "That probably doesn't happen until later this summer or this fall, so that's why I would not necessarily be surprised to see some market sell offs between now and that." Searching for opportunities As in any market, how investors trade depends heavily on risk tolerance. That means differentiating between narrow or wide economic moat stocks, referring broadly to whether a company has a long-term competitive advantage and generates excess returns on invested capital. Morningstar also organizes stocks by uncertainty levels. Even within these buckets, investors should consider snatching up a stock when its valuation drops, or falls below fair value, Sekera said. "When something falls to a low enough valuation, even when it becomes a higher risk — as long as they can tolerate higher risk — we'd look towards those stocks that might even be cheaper," he said. Currently, Sekera views many financial and banking stocks that took a hit during last month's crisis as some of best opportunities for investors. He named Charles Schwab as a top pick, calling the recent drop "unwarranted." SCHW 3M mountain Stock performance over the last three months Other undervalued stocks include asset managers and investment banks such as BlackRock and Goldman Sachs , and financials with differentiated business models not as dependent on deposits, Sekera said. For regional bank stocks, Morningstar expects earnings to slowly decline through 2023. But after the recent selloff, many trade at a major discount to their long-term intrinsic valuation, Sekera said. He highlighted names such as M & T Bank , Comerica and U.S. Bancorp , which sold off sharply. "This is going to be a sector that will be under pressure over the course of the year," Sekera said. "This isn't something that I would expect will necessarily just snap back, but there are a lot of opportunities here for investors to start doing their due diligence and deciding where they want to play." Although large caps may offer fewer discounted opportunities for investors, Morningstar still views Alphabet and Meta Platforms as significantly discounted even with their surging share price this year, Sekera said. META YTD mountain Meta Platforms' stock year to date Last year, investors seemed to flock toward defensive stocks as economic fears mounted. Today, Morningstar views many of those names, in areas such as energy, healthcare and consumer defensives, as fully valued. Instead, investors may want to focus now on cyclicals that are trading at a significant discount. That includes companies such as Carnival and Hasbro . Another is Lithium Americas , which should benefit from skyrocketing lithium prices as the electric vehicle market grows. Opportunities in small- and mid-cap stocks Small and mid-cap stocks represent perhaps the most attractive areas for investors searching for value, according to Morningstar. These stocks, while susceptible to near-term pressures ranging from interest rates to consumer demand, should see significant gains and look more attractive than some large-cap stocks trading at a premium, Sekera said. Some of the most undervalued stocks among small caps include Western Union , Portland General Electric , and toymaker Mattel , the last of which suffered rom shipping bottlenecks working their way through the system. Among midcaps, Morningstar favors names like Kellogg , Domino's Pizza and Equifax , all of which it views as wide moat, with medium uncertainty. "Again, small cap stocks will be under pressure probably for the next couple of quarters," Sekera said. But as was true in 2022, "when they start to move, they will move quickly."