Key Takeaways
- The U.S. stock market is currently just 3% off from fair value.
- While the market weight is mainly on stocks, it feels somewhat heavy.
- There isn’t much of a safety margin regarding potential risks ahead.
- The market seems stable for now, but increased volatility is anticipated in upcoming quarters.
June 2025 U.S. Stock Market Outlook and Valuation
As of May 30, 2025, the U.S. stock market was valued at a modest 3% discount. Historically, it has hovered around the midpoint—meaning half the time, valuations were higher and half, lower. We still consider the market weight at this level, but we hope to see more safety margins given the risks of potential downturns.
For instance, on April 4, 2025, the price/fair value ratio dropped below a 17% discount. At that point, investors felt there was a sufficient safety margin for long-term investments, prompting suggestions to adopt an overweight stance. Following a quick rebound, valuations realigned with fair value, returning to market weight as those rapid profits were secured.
Is This Just the Eye of the Hurricane?
Last month, it seemed we were entering a calmer period as May progressed. The U.S. stock market appeared optimistic against high risks looming this year. However, this calmness could signify being in the eye of a storm, juxtaposed with the turbulence that may follow.
Tariffs and Trade Negotiations
Until negotiations conclude, ongoing issues surrounding trade tariffs remain a notable risk. Though discussions have commenced, a concrete agreement seems far off. Moreover, legal disputes in the U.S. are raising doubts about the efficacy of tariffs, entangling matters in the appeals court for the short term.
Right now, it’s tough to predict when trade discussions will wrap up or what the final terms will be. The worst tariffs have been paused, but it’s likely that new contracts won’t be finalized until deadlines creep closer. In the meantime, headlines could either positively or negatively sway the market, especially as countries might leak information to create volatility in the U.S.
Economic Growth Slowing
In the coming quarters, various elements will likely skew economic and corporate revenues. For example, the GDP for the first quarter of 2025 came in at a mere 0.3%, largely influenced by bulk imports ahead of the tariff implementation. Excluding this factor, the basic economic growth rate probably would have been positive.
As for the second quarter, the GDP may show a reverse effect. While estimates suggest 4.6%, Morningstar believes the real underlying growth should decelerate compared to Q1. Forecasts indicate that actual growth rates (excluding the pre-tariff import spike) will progressively decline for the rest of 2025.
Additionally, supply chain disruptions may further confuse revenue reporting. If our forecasts hold true, the results will likely reveal compromised revenue growth, disappointing investors, and leading to a downward market valuation adjustment.
Rising Yields Creating Market Anxiety
After a lackluster auction of U.S. Treasury debt in 2020, sensitivity to Treasury yields has heightened. A decrease in yields might lead to overall market valuation reductions if it breaches the 5% threshold.
Furthermore, easing monetary policy isn’t expected soon. According to market predictions, the Federal Reserve doesn’t plan to cut federal rates immediately. Until the September meeting, there’s over a 50% chance for such a cut.
Investors’ attention isn’t limited to the U.S. bond market. Long-term Japanese bond yields have surged, with a 40-year yield rising significantly before pulling back. As these yields increase and bond prices drop, many are questioning potential losses for Japanese banks and insurers, especially given the country’s unique demographic and debt challenges.
Outlook
In the next few quarters, expect higher volatility as these factors unfold. The geopolitical landscape continues to introduce uncertainty, adding another layer to watch. If we predict correctly, and another sale materializes, investors might want to keep some resources ready to shift to an overweight position, similar to what occurred in early April, should valuations support it.
Positioning for a Potentially Turbulent Market
Based on our assessments by style, we recommend the following for investors:
- Overweight value stocks currently trading at fair value and a 14% discount.
- Market weight core stocks valued fairly with just a 1% discount.
- Underweight growth stocks at an 11% premium.
On the capitalization front, we suggest:
- Both large and mid-cap stocks are slightly underweight, while small caps should be overweight.
- Small caps are trading at fair value with a notable 20% discount.
Although small caps are undervalued, the overweight stance shouldn’t be seen as a short-term play; it may take a while for market views to shift positively. Historically, small caps perform best when monetary policy eases, the economy recovers, and long-term interest rates decline.
However, we’re not in that environment right now. The outlook for monetary policy has us in a particularly uncertain situation. Morningstar’s economic projections point to a slowdown in U.S. growth, with expected long-term interest rates stabilizing around 4.25% to 4.75% since last November.
Sector Valuations and Takeaways
In May, the technology sector led returns, climbing by 10.30%, and is now close to fair value.
The communications services sector followed, up 9.59%, though it remains undervalued. Metameta surged almost 17%, yet is classified as a four-star stock at a 16% discount. Alphabet, meanwhile, increased by 7% but still trades at a 28% discount, maintaining its five-star status.
The consumer discretionary sector saw an 8.86% rise last month, largely driven by Tesla’s impressive 18% jump, responsible for nearly 40% of the sector index’s market cap, which skews the overall sector average. At this point, ratings for the consumer discretionary sector have returned close to valuable levels.
In May, the real estate sector held steady with valuations at a 10% discount, coinciding with an increase in fair value. Conversely, the energy sector only grew by 1.58% last month, remaining substantially undervalued at a 14% discount.
Healthcare stands out as the only sector with losses, down 4.96% in May, primarily influenced by declines in Eli Lilly and UnitedHealth.
The consumer staples sector remains labeled as overrated, particularly distorted by major stocks like Walmart and Procter & Gamble, which account for a significant portion of the sector’s weight. If these stocks are excluded, other sectors trade closer to a more reasonable 6% discount. Among the most overvalued sectors are utilities and financial services, with few stocks possessing high ratings.
