Susan Dziubinski: Hi, I’m Susan Dziubinski with Morningstar. Every Monday morning I sit down with Morningstar’s chief U.S. market strategist Dave Sekera to discuss one thing that’s on his radar this week, one new piece of Morningstar research, and a few stock picks or pans for the week ahead. I understand you’re traveling today, Dave, so thank you for taking out some time to chat. On your radar this week, we have the Fed meeting. What’s the market expecting?
Dave Sekera: Good morning, Susan. Joining you today from the great state of Tennessee. So this week we do have the Fed, and to be honest, I actually kind of hope viewers took my advice last week to take a bit of a breather because we certainly could see a pickup in volatility this week. Now, since the last Fed meeting, we’ve been of the opinion that the Fed is going to halt hiking rates any further at this point, and it does look like the market agrees with us. Right now, the market-implied probability of another rate hike is only 30%. Now, the caveat there is that we do have CPI coming out Tuesday morning, and then we have PPI coming out Wednesday morning. So, if either or both of those are higher than expected, that certainly could put another rate hike back on the table for the Fed.
Dziubinski: The Fed meets again in July. What’s the market expecting for that meeting?
Sekera: Well, this is interesting here. So, the market is pricing in that they’re going to pause here this month, but then the market probability of a hike then in July is 66%. So, it’s actually a 53% probability that they hike to 5.25% to 5.50%, and then a 17% probability that they hike to 5.50% to 5.75%. Now, my own personal opinion is that I think if the Fed does pause this month, it’s going to hold interest rates there for a while. I don’t think the Fed’s going to want to be seen as really being that reactionary to any individual inflation prints. I think they want to be seen as a steady hand guiding the economy.
Even though inflation, maybe it’s not declining as fast as the Fed would prefer, but I know our U.S. economics team does still expect that inflation will continue to keep moderating over the course of this year. But we do have both that CPI and PPI print coming out, so we’ll see how those turn out. But again, we do think that the Fed is going to pause here and that it will probably pause throughout the end of the year, and it’ll only be at the end of the year that we think the Fed actually could turn around and start cutting rates.
Dziubinski: Let’s pivot over to some new research from Morningstar, and that’s your stock market outlook. In it, you shared some interesting research about what’s been driving the market’s performance this year. Tell us about that.
Sekera: It’s been a pretty good year for the market. The US Market Index is up 12.4%, but the gains this year have been just really concentrated. I mean, almost extraordinarily concentrated in just a handful of names. We did an attribution analysis, and what that shows is that there are only 10 companies that actually account for essentially the entire market return thus far this year.
Dziubinski: Notably, many of these 10 stocks were actually undervalued heading into the new year. So where are their ratings today?
Sekera: Exactly. So of these 10 companies, nine of those 10 were rated either 4 or 5 stars at the beginning of the year, and at this point they’ve run up so much that only one now is rated 4 stars, meaning that we think it’s undervalued. Six of those now are 3-star, meaning that they’re trading pretty close to what we think is fair value, and three are now 2-star, meaning that they’re starting to trade into an area that’s well above our valuation. So, I think that for the market really to continue this rally that we’ve had, what we’re going to need to see is that the rally is going to need to spread out into other areas of the market, and specifically according to our valuations, into the mid-cap and the small-cap stocks and into the value category.
