Stock market outlook: Stocks start to look more attractive

Some fears are overblown, leading to attractive valuations in financial services and consumer cyclical.

Elizabeth Collins 29 March, 2016 | 5:00PM

Although the S&P 500 had fallen some 10% from the start of 2016, a strong bounce from mid-February puts the U.S. stock market basically back to where it started the year. As of mid-March, the market-cap-weighted-average price/fair value ratio of our coverage universe is 0.92, down from 0.96 as of Dec. 15, 2015.

The financial services sector is by far the most undervalued based on our estimates of companies' intrinsic values, with a market-cap-weighted price/fair value ratio of 0.78. While investors are right to be somewhat concerned about energy-related credit losses, currently low interest rates, and possible interbank contagion, the magnitude of the coming losses priced into many bank stocks is overdone, and we find many to be sporting attractive valuations today. We believe most bank's exposure to the energy sector is ultimately manageable. And we believe fears regarding counterparty risk and notional derivative exposures are also overblown. Net exposures to individual asset classes, events or counterparties are relatively manageable -- especially in the case of interest rates, which make up a bulk of reported notional exposures.

That's not to say that it won't be a painful year for bank earnings. Net interest margins will likely remain depressed. Credit quality will likely deteriorate. And poor stock market returns would be bad news for capital markets and wealth management businesses. But to us, it seems like for many banks investors have priced in this pain, and much more. For example,  Citigroup (C) has been hit hard by fears over its emerging-markets exposures, but we think the long-term outlook for the bank is actually brightening. The company could take losses of 36% on its entire emerging-markets exposure (which would be at the high end of historical emerging-markets crisis ranges for loss rates) and maintain its current 12% Common Equity Tier 1 ratio.

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Anglo American PLC ADR12.28 USD2.50
Citigroup Inc52.65 USD6.47
Fiat Chrysler Automobiles NV10.11 USD3.37
Southern Copper Corp41.66 USD3.30
Teck Resources Ltd Class B10.99 USD2.14
Vale SA ADR10.79 USD1.51
Wynn Resorts Ltd74.13 USD4.22

About Author

Elizabeth Collins

Elizabeth Collins  Elizabeth Collins, CFA, is global head of equity research for Morningstar Research Services LLC, a wholly owned subsidiary of Morningstar, Inc. In this role, she leads the global equity research team, which focuses on providing in-depth, fundamental equity research based on sustainable competitive advantages and long-term valuation analysis. Before assuming her current role in 2018, Collins was director of North American equity research. She joined Morningstar in 2005. She holds an MBA from DePaul University and is coauthor of Why Moats Matter: The Morningstar Approach to Stock Investing, published by John Wiley & Sons in 2014.

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