US Stocks Now Undervalued, With a Caveat
The latest earnings season is drawing to a close with much for investors to cheer. Strong revenue growth and unusually high profit margins have led to a 13.1% increase in profits for large US companies over the last 12 months, according to FactSet. These positive results alongside the US stock market’s growing concentration in companies benefiting from the rapid growth in AI has led Morningstar’s analysts to increase their estimates of the market’s fair value. As a result the average US company under Morningstar’s coverage now appears undervalued, implying higher than usual future returns.
However, this concentration in tech stocks - companies dependent on long term future growth - brings with it increased risk of lurching price movements driven by short-term changes in investor sentiment.
This was evident from the roller coaster ride investors experienced last week. Although the US market ended the week flat, the index rose 2.3% on Wednesday morning before falling 3.3% by Friday morning and subsequently recovering. The seemingly benign final outcome also masked a sharp dispersion in price movements exemplified by the gap between healthcare, which rose 3.6% and consumer cyclical stocks, which fell 2.6%.
While it is tempting to draw simple inferences from these movements, it is important to note that the decline of AI-beneficiaries Amazon AMZN, which fell 3.4% and Tesla TSLA, which lost 9.3%, accounted for more than the entire decline in the sector, indicating that most consumer cyclical stocks ended the week modestly higher in aggregate. A good example of this is McDonalds MCD which rose 2.9%.
At each point of the journey last week there would have been many investors predicting the next move. This focus on the near future when we feel uncertain is both natural and the enemy of good investing. To be successful, we must think a little further ahead and consider a range of possible outcomes: Morningstar has published its Global Investment Outlook for 2026.
Rather than making specific forecasts about the year ahead, the outlook helps investors think through the key challenges they are likely to face in 2026 and in doing so make better investment decisions.
Diversification Challenges at Home and Abroad
Creating diversification within a portfolio is one of these challenges. Given the concentration in the US market, it is natural to seek diversification by investing in international markets. However, last week reminded us that concentration is not a purely US problem. Despite the large number of stocks and countries represented by the emerging markets, which rose 0.4%, this index was held back by a 2.4% decline in semiconductor manufacturer Taiwan Semiconductor TSM which accounts for 9.7% of its value.
This demonstrates the importance of understanding the fundamental drivers of the asset classes through which we are seek diversification in a market where a single investment theme, in the case the adoption of AI, can increase the correlation of assets across the globe. While the developed markets outside the US played a more traditional diversifying role rising 1.7% last week, this gain for US investors was supported by the weakening of the US dollar. In such market conditions, it is more than usually important to be selective in our investing activities, identifying assets that are likely to behave differently to the dominant stocks and market themes when during periods of sharp price movements.
Fed Tackles the Economic Data Backlog
Following the end of the Federal government shutdown, the Bureau of Labor Statistics will start tackling its backlog of delayed releases starting with the September Employment Report on Thursday. With over 30 reports delayed, many of which require the collection of timely data, the shutdown is likely to create a permanent gap in the economic record. This gap already appears to be influencing policy as Fed Chair Jerome Powell stated last month “What do you do when you’re driving in the fog? You slow down.” This slowing of policy started appearing in interest rate expectations last week as the probability of a cut at the next meeting in December fell from 67% to 44%. The minutes of the last FOMC meeting are therefore likely to be closely scrutinized when they are released on Wednesday.
Nvidia Earnings Up Next
Alongside the belated economic data, investors will be closely watching Nvidia’s NVDA results to gauge the health of the AI ecosystem. Signs of unexpected strength or weakness could move equity markets in the latter part of the week. You can find a look at what Morningstar’s Brian Colello will be watching when Nvidia reports here, and company and economic releases can be tracked on this calendar.
