Key Takeaways
- The US stock market is trading at an 8% discount.
- Investors should look to market-weight stocks overall but overweight value and core.
- Sector valuations rise toward fair value from deeply undervalued levels, and energy is increasingly attractive.
May 2025 US Stock Market Outlook and Valuation
As of April 30, 2025, according to a composite of our valuations, the US stock market is trading at an 8% discount to fair value, the same level as at the end of March. However, the month-end calculation fails to capture the market’s plunge in early April after the US announced tariffs and its subsequent rebound. For example, the price/fair value fell as low as a 17% discount on April 4, 2024. At that level, we recommended a move to an overweight position as we thought that the discount was more than enough of a margin of safety for long-term investors.
Stocks subsequently rallied following the announcement of a 90-day pause on tariffs as trade negotiations began. Considering how quickly the market has rebounded and valuations have bounced back, we think now is a good time to lock in profits on that overweight position and move back to a market-weight stance.
Eye of the Hurricane
The earliest signs of the impending stock market hurricane emerged in March as the bear market in artificial intelligence stocks led the broad market downward. Yet, this was a tempest in a teapot as the storm hit once President Donald Trump announced the tariffs. Stocks quickly plunged over the next week, hitting an official bear market as the Morningstar US Market Index bottomed out at a 20% correction from its highs.
Seemingly just as quickly, the skies began to clear as President Trump announced that he would pause those tariffs for 90 days to allow trade negotiations to commence. Stocks surged higher and have recaptured those losses, bringing the market valuation back to where it was at the end of March.
Heading into May, it appears that we are in a period of relative calm. Yet, we think there is a high probability of more volatility yet to come. Trade negotiations have reportedly begun, yet finalized agreements don’t appear to be anywhere near fruition. The deadline for the 90-day pause isn’t until July 8, and we suspect it won’t be until we are nearing that deadline that new agreements may be finalized.
In the near term, we think the economy and corporate earnings will be distorted by a few factors. First, we have already seen a significant amount of purchasing ahead of the tariffs, which pushed down the first-quarter gross domestic product. Second, we suspect supply and transportation dislocations will result in numerous disruptions and earnings distortions. Lastly, Morningstar’s US economics team had already projected that the rate of real economic growth would slow sequentially throughout 2025, and these dislocations will likely exacerbate this trend.
If we are correct, and the stock market suffers another selloff, we recommend keeping enough dry powder to move back to an overweight position once valuations warrant.
Should You Sell in May and Go Away?
There is an adage to “sell in May and go away” as market returns are seasonally subdued over the summer. With the market still trading at a reasonable discount to fair value, we’d recommend that long-term investors remain at a market-weight position. Yet, with the economy slowing, the Federal Reserve likely on hold for now, and trade negotiations and tariff disruptions on the horizon, we think positioning will be especially important to hedge against a potential summer swoon.
We think investors can position themselves to ride out near-term spring and summer turbulence in stocks:
- With long-term durable competitive advantages as indicated by a wide or narrow Morningstar Economic Moat Rating.
- With an Uncertainty Rating of Low to Medium.
- Trading at a significant margin of safety below our valuation
- That have an attractive dividend yield.
- That are in the value category, which will benefit from ongoing rotation out of the growth category.
- That are in defensive sectors, which should benefit from a rotation out of economically cyclical sectors.
Based on our valuations, by style, we advocate that investors:
- Overweight value stocks, which trade at a 12% discount to fair value.
- Overweight core stocks, which trade at an 11% discount to fair value.
- Underweight growth stocks, which trade at a 3% premium to fair value.
Sector Valuations
Since our market update on April 9, sector valuations have generally moved higher in relation to the broad market rebound. The greatest laggard has been the energy sector as oil prices have continued to slide lower. The energy sector is now the second-most undervalued sector, following the communications sector. The consumer cyclical and real estate sectors are tied as the third-most undervalued sectors.
The consumer defensive sector remains the most overvalued, yet the sector valuation is skewed into overvalued territory by Costco COST and Walmart WMT, which have 1-star Morningstar Ratings, and 2-star-rated Procter & Gamble PG. These three stocks account for 31% of the market capitalization of the index. Excluding these three stocks, the rest of the sector trades at a more reasonable 6% discount to fair value. The utilities and financial-services sectors are the next two most overvalued sectors, but their overvaluation is more widespread, and few stocks are rated 4- or 5-stars.
