Key Takeaways
- Market volatility has been elevated this year, but economic data has remained stable.
- Within the equity space, opportunities lie in international, small-cap, consumer discretionary, and healthcare stocks.
- The fixed-income sector is broadly attractive, but certain sectors, such as corporate credit, are overvalued.
After the roller coaster ride for stocks and bonds in the first half of 2025, opportunities remain in corners of the markets that have been left behind. At the Morningstar Investment Conference in Chicago, Morningstar Investment Management’s chief multi-asset strategist Dominic Pappalardo and chief investment officer Philip Straehl shared their perspectives on the market and where they see opportunities.
In equity markets, Pappalardo and Straehl see value in international stocks, small caps, global consumer discretionary stocks, and healthcare names. In the fixed-income markets, they recommend a large overweight position in US Treasuries and a slight overweight position in emerging markets.
Market and Economic Backdrop
“We had a dramatic selloff in April that lasted eight or nine trading days, and it was really uneven across different sectors,” said Pappalardo. “That was quickly followed by a violent rebound in US equities, in which many of those sectors bounced back even higher than they were prior to the April 2 selloff.”
Notably, international markets have outperformed the United States in the first half of 2025, with regions such as Germany and Latin America up close to 30% while the US market is up just 4%. “The trend of the US market vastly outperforming the globe really ended this year after a several-year run,” Pappalardo said.
Despite the volatility, Pappalardo noted that economic data has been very stable. “Factors like GDP, unemployment, and even inflation have been really steady throughout the first six months of this year,” he said.
Where to Invest in Stocks
Straehl pointed to four main opportunities for equity investors at the halfway mark of 2025: consumer discretionary stocks, healthcare stocks, international stocks, and small-cap stocks.
The main driver of these opportunities is valuation. The consumer discretionary sector trades at a 15% discount to its fair value estimate, the healthcare sector trades at a 13% discount, and small caps trade at a 20% discount.
Straehl zeroed in on consumer stocks specifically, pointing to three main reasons they have become undervalued. The first is cost inflation. “You have food companies and beverage companies that were significantly impacted by the rise in costs of commodities—eggs, coffee, you name it. A lot of things have risen more than average inflation. Those companies have to adjust and find ways of being more profitable, but we think that dynamic still weighs on expectations for these stocks.”
Another reason is sluggish Chinese growth, which “has been disappointing post-pandemic,” Straehl said. “We have seen some more positive trends, given some of the stimulus announcements. But overall, relative to the pre-pandemic level, the consumer growth rate in China has significantly decelerated.”
The third reason is the tariff rate. “A lot of consumer companies have complex supply chains and have to source goods across many different jurisdictions,” Straehl said. “And the uncertainty we’ve witnessed in recent weeks, which is certainly not over yet, has weighed on the pricing of some consumer stocks.”
Over the next 10 years, Straehl expects a negative change in the valuation of US companies and a further depreciation of the US dollar, giving international stocks room to outperform. “We think US stocks will have a decent return, around 6% on a nominal basis, but we think international stocks and emerging-market stocks are priced to deliver higher returns.” He forecasts an 8% return on developed-market stocks and an 11% return on emerging-market stocks.
Where to Invest in Bonds
Pappalardo explained that fixed income is at the point where just having it in a portfolio offers some value. “That value could come from downside protection if volatility spikes again, or it could come from the income fixed income generates when you have Treasury yields in the mid-4% range in the United States, with international yields even higher in some cases,” he said.
He noted that, unlike in recent history, investors can get solid yields over 4% on US Treasuries and even higher rates on emerging-market debt, which makes fixed income attractive. “With fixed income, the opportunity lies in the fact that yields are higher across the spectrum right now,” he said. “We don’t particularly like any segment. There are some that we think are fairly valued, but none that we have really strong buying opinions about, like we do in equities.”
Pappalardo sees some value in emerging-market debt, which is trading at a 10%-15% discount to its fair value estimate. He recommended keeping a slight overweight position in this segment.
The largest overweight position he recommended is US Treasuries. “Our recommendation is to hold high-quality fixed-income insurance, because the pricing doesn’t align for taking on additional credit risk at this point,” Pappalardo said. He recommended investors position themselves in the middle of the yield curve, in the five-to-10-year maturity range.
There’s one segment where Pappalardo does not see value. “Corporate credit is trading at a really expensive valuation right now relative to the credit spread, which is the additional yield you earn over and above treasury bonds for taking on credit risk. Those ratios are about 50%-60% of what we think the fair value is.”
