Stocks ended the week a little lower with the Morningstar US Market Index down 0.25% following a sharp fall on Friday, as the US jobs report showed that unemployment fell to 4% in January and hourly wages rose by 4.1% year over year. This naturally dampened expectations of further interest rates cuts, with CME’s FedWatch indicating an 83% probability that rates cuts will be limited to 50 basis points before the end of the year. You can read more about the employment data here. This view was reinforced by a raft of comments from Federal Reserve officials over the week who emphasized the strength of the economy, the risk of higher inflation and the desire for more evidence of moderating prices before lowering interest rates further.
Consumer cyclical stocks were in the vanguard of the market decline, falling 3.1% as index heavyweights Amazon AMZN and Tesla TSLA declined 3.6% and 10.6% respectively. Despite delivering earnings above consensus expectations, Amazon’s outlook for future earnings appeared to disappoint investors. Morningstar’s Amazon Analyst Dan Romonoff had more conservative expectations and upgraded the fair value of Amazon following the results. You can read Dan’s note here.
Stock Fair Values Matter
Tesla remains at a 44% premium to Morningstar’s estimate of fair value, reminding us that a sharp decline in the price of an asset does not mean it offers good value, merely that it is less expensive than it was. The reverse is also true. A rise in the price of an undervalued asset does not negate its investment value but may simply represent a higher probability that the model underlying the fair value is accurate.
This is important as the expected return of an undervalued asset is not merely the difference between the current price and fair value, but rather the probability-weighted return of a range of possible outcomes. Although a declining gap between price and fair value reduces the absolute expected return, an increase in the probability of that outcome can more than compensate for that loss, increasing the attractiveness of the asset.
Magnificent Seven Earnings Continue
While probabilistic thinking is always a vital for an investor, it is more important than usual in a polarized market with large gaps between prices and fair values as opportunities appear superficially less attractive as these gaps close while discouraging further investment, while the expected return may be rising.
Movements in these gaps were also evident in other members of the so-called Magnificent Seven that released earnings last week. Although Apple AAPL, Alphabet GOOGL and Microsoft MSFT all fell, the latter moved deeper into discount territory Apple moved closer to its fair value. You can catch up on all of the recent and upcoming earnings releases on Morningstar’s dedicated earnings page.
Earnings Growth Pick Up
With almost two thirds of companies having reported results, the expected year-over-year earnings growth is 16.4%, significantly higher than the 11.8% expected at the start of the quarter, according to FactSet. Expectations among analysts are also high for 2025 with earnings growth expected to be 13%. It is worth noting that this optimistic assessment flatters the forward price/earnings ratio of the US market and is a reminder of the benefits of using longer term valuation measures.
All Eyes on CPI
Inflation will be back in the spotlight this week with the core Consumer Price Index (CPI) expected to be a little lower than last month at 3.1%. Following the stronger data last week and moderating interest rate expectations, this data will be closely watched and may reinforce expectations that rates will stay higher for longer. Look out for this any resulting disappointment among investors to be directed towards those companies with the most optimistic growth assumptions. You can follow all the economic and earnings announcements on this calendar.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
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