1. Basic Materials Although basic materials stocks lagged the broader market in the second quarter, they have massively outperformed since the depths of the pandemic, according to director Kris Inton. He notes that lithium prices have risen since the start of the year, thanks to rising electric vehicle sales and reduced supply in 2020. Chemical producers continued to see demand recover; Morningstar expects a continued volume recovery through 2021. Deicing salt prices fell last winter, but analysts expect prices to rise in the 2021–22 season, in part because of reduced supply from a mine closing.
Compass Minerals International (CMP), DuPont de Nemours (DD), Sociedad Quimica y Minera de Chile (SQM)
2. Communications Services Communications services stocks as a group outperformed the broader market in the second quarter, with Alphabet and Facebook accounting for most of the sector’s gains, director Mike Hodel says. “As 2021 has progressed, we’ve sharply increased our expectations for advertising growth based on both cyclical and emerging longer-term factors.” On the development front, Morningstar analysts think AT&T’s announced spinoff, WarnerMedia, should have the scale and content needed to take on the likes of Netflix and Disney, Hodel says. In addition, ViacomCBS issued new equity in March, and they expect the added capital to serve it well.
Alphabet (GOOG), Lumen Technologies (LUMN), ViacomCBS (VIAC)
3. Consumer Cyclicals Consumer cyclical stocks lagged the market in the second quarter after a sizable outperformance over the trailing 12 months. The median consumer cyclical stock is about 12% overvalued, according to director Erin Lash. However, the power-sports companies Morningstar covers offer some opportunity, she says. As more states reopen, analysts expect consumers to return to in-person dining and other immediate satisfaction experiences such as bars, casinos and travel. Moreover, global shipping delays have lengthened wait times for many discretionary goods.
Hanesbrands (HBI), Malibu Boats (MBUU), Polaris (PII)
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4. Consumer Defensive The consumer defensive sector lagged the broader market in the second quarter, but remains slightly overvalued by about 4%, says director Erin Lash. Tobacco names still offer an upside. “The market seems to underappreciate the cash generation these businesses boast,” she says. Morningstar does not expect the pressure of cost inflation to subside in the near term, owing to elevated demand and supply-chain disruptions.
Coca-Cola Femsa SAB de CV (KOF), Kellogg (K), Pilgrims Pride (PPC)
5. Energy Energy stocks rallied for the third consecutive quarter, and Morningstar expects a full recovery in demand by 2022, says director Dave Meats. He notes that energy stocks as a group are about fairly valued, but opportunities exist across all segments, with services and integrated names trading at meaningful discounts. Analysts think current oil prices are frothy, with the West Texas Intermediate benchmark 33% higher than Morningstar’s $55-per-barrel midcycle forecast.
EOG Resources (EOG), Equitrans Midstream (ETRN), Schlumberger (SLB)
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6. Financial Services Financial services names slightly outperformed the market in the second quarter. The average stock in the sector trades 10% above Morningstar’s fair value, according to director Michael Wong. He notes that whether or not higher inflation is transitory is up for debate; nonetheless, he says, higher-than-expected inflation and interest rates should help many financial services companies, including payment firms and banks.
American International Group (AIG), Berkshire Hathaway (BRK.B), Wells Fargo (WFC)
7. Health Care Health care sector valuations appear a bit high, says director Damien Conover, with the average stock in our coverage universe trading about 11% ahead of Morningstar’s fair value estimate. Analysts consider the sector’s fundamentals strong, and expect to see accelerated earnings growth for industries affected by pandemic restrictions, such as elective procedures. Drug manufacturers and biotech firms remain the most undervalued — more than likely driven by expected changes in U.S. health care policy, according to Conover.
BioMarin Pharmaceutical (BMRN), Merck (MRK), Vertex Pharmaceuticals (VRTX)
8. Industrials Industrial stocks lagged in the second quarter, yet the sector remains overvalued with the median stock in Morningstar’s coverage universe trading about 17% above fair value. Nevertheless, pockets of opportunity exist, says director Brian Bernard. The Biden administration’s infrastructure spending proposal should boost construction-related industrials, though that opportunity is already being priced into the stock. Airlines and aerospace suppliers have benefited from increasing leisure air travel; Morningstar projects full recovery for North American airlines by 2024.
Crane (CR), General Electric (GE), Lockheed Martin (LMT)
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9. Real Estate The real estate sector has performed in line with the broader market since the successful development of COVID-19 vaccines, analyst Kevin Brown says. The hotel and retail industries, however, have tremendously outperformed on news of successful vaccine development after lagging their peers for much of 2020. Brown still sees some value picks among these subsectors today.
Park Hotels & Resorts (PK), Simon Property Group (SPG), Ventas (VTR)
10. Technology Technology stocks outperformed the broad market in the second quarter; now the sector is about 8% overvalued by Morningstar metrics, according to director Brian Colello. He sees robust fundamental tailwinds supporting future growth in cloud computing, 5G and the “internet of things.” Morningstar likes “moaty” software companies that generate revenue through subscriptions with little risk of cancellation, though valuations are high among remote-working software names.
Advanced Micro Devices (AMD), Salesforce (CRM), VMWare (VMW)
11. Utilities With inflation on the rise and talk of rate increases on the horizon, the utilities sector faces an uphill battle in the market, says strategist Travis Miller. But utilities provided a cushion for earnings and dividend growth by strengthening their balance sheets while rates were low. Miller notes that clean energy growth is “in full throttle,” meaning a long pipeline of steady, transparent growth.
American Electric Power (AEP), Edison International (EIX), NextEra Energy (NEE)
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