While the stock market seems “fully valued” at the end of its sixth consecutive year of positive returns, recent extreme volatility creates “pockets of opportunity” — particularly in the hard-hit energy sector — according to Morningstar, which released its quarter-end insights Monday.
Yes, the S&P 500 is trading near all-time highs, says Morningstar analyst Matthew Coffina.
But the collapse in oil prices — Brent crude is under $60 a barrel from $115 a barrel back in June — has precipitated a nearly 25% plunge in energy stocks in the past quarter.
That downward pressure on energy companies has led to a surge in the number of stocks earning all five of Morningstar’s coveted stars.
The Chicago-based investment firm — generally better known for its fund ratings — has been fairly stingy in its stock ratings in recent years.
In the quarter ending just three months ago, the firm gave five stars to just 10 companies across the entire universe of stocks its 100-plus analysts cover. To earn that rating, a company must have both sustainable competitive advantages and be cheap. That last criterion is especially hard to achieve in an aged bull market.
But the sell-off in energy and other areas of the market (such as basic materials) has swollen the list of five-star companies from 10 to 64, more than half of which, 37, are in energy.
The reason for this “pocket of opportunity” in a fairly priced market is the view of Morningstar’s stock analysts that oil’s retreat is just temporary. The firm calculates stock prices’ fair value based on long-term (i.e., beyond three years) expectations, and Morningstar’s “long-run oil price forecast remains $100/barrel for Brent and $90/barrel for West Texas Intermediate.”
Coffina attributes the current plunge to a basic supply and demand imbalance in the volatile commodity.
On the supply side, North American production has surged, accompanied by unexpectedly high production in the Middle East and North Africa, despite regional turmoil. At the same time, energy demand has ebbed because China’s growth is decelerating while other major economies — Europe, Japan and Brazil among them — are flirting with recession.