US stocks are soaring on the back of positive economic data and large interest rate cuts.
The S&P 500 flirted with its all-time high on Friday after a strong labor market report, even though risks like geopolitical tensions and election uncertainty hang over the market.
However, fairly valued investments are tough to come by right now, according to Morningstar.
Top minds at the leading equity research firm found that US equities were 3% overvalued heading into the fourth quarter. Although that doesn't sound like an unhealthy extension, the market has only been that expensive 15% of the time since late 2010, wrote Dave Sekera, Morningstar's chief US market strategist, in a recent report.
Stocks earned that premium after economic growth exceeded expectations as inflation fell. The most aggressive rate hikes in 40 years were no match for US GDP growth, which has held up admirably in the last two years due to factors like consumers' excess savings and government spending, the note read. Inflation falling from multi-decade highs was also a crucial tailwind.
"The combination of an economy that has held up better than expected, moderating inflation, declining interest rates, and easing monetary policy has led to stronger equity market returns than we had expected at the beginning of the year," Sekera and his colleagues wrote.
Additionally, US stocks were aided by a surge in spending on artificial intelligence. Enthusiasm about that burgeoning technology drove growth-oriented companies to record highs.
Therefore, it's no shock that those growth stocks are responsible for the market's lofty valuation. The group is trading 13% above Morningstar's fair-value estimate, compared to a 2% premium for core stocks and a 3% discount for value names.
Similarly, large caps are 4% more expensive than they should be, in Morningstar's view, while mid caps are close to fair value while small caps are unusually cheap at a 15% discount.
Morningstar had revised its fair-value estimates upward as the AI-powered rally raged on and consumer spending remained solid, but stocks still exceeded those targets.
Attractively priced equities are scarce, but Sekera is sure that deals are still out there.
"While the overall market appears to be priced to perfection, we continue to see undervalued opportunities, albeit much fewer and further between than earlier this year," Sekera wrote.
33 top stocks to ownIn Morningstar's fourth-quarter note, the firm designated 33 stocks as its top picks across sectors and groups like cyclicals, defensives, and economically sensitive companies.
Naturally, some parts of the market are much cheaper than others. Only the communication services and energy sectors are cheap, according to Morningstar's methodology, while consumer defensives — better known as staples — and utilities are too expensive.
Still, investors can succeed by shifting toward the stocks that Morningstar put the spotlight on.
"To outperform, we think investors will need to look for contrarian investments and story stocks," Sekera wrote.
Below are Morningstar's 33 top picks heading into the fourth quarter in alphabetical order by sector within their broader groups, which are also in alphabetical order. Along with each company is its ticker, market capitalization, group, sector, rating, price target, upside to that target, and selected commentary from Morningstar.