Key Takeaways for Q2 2025 Stock Market Outlook
- AI stocks face significant downturns.
- Value stocks show remarkable resilience, outperforming growth stocks.
- Wide-moat stocks are now highly attractive.
- Small-cap stocks remain undervalued, with potential long-term upside.
In our 2025 Market Outlook, we highlighted that the stock market was teetering on the edge, priced to perfection with a ~5% premium to fair value. The pivotal question was: “Will it last?” The landscape has since shifted dramatically, with growing investor appetite for value stocks as growth stocks faced substantial corrections.
Market Valuations: Dropping to Fair Value
As of March 24, 2025, our research shows the US equity market trading at a price/fair value estimate of 0.95, suggesting a solid 5% discount to our fair value estimates. This places the market at the lower end of our fair value range, indicating potential for upward price movement going forward.
Value Stocks: The Resilient Heroes
Despite significant declines among growth stocks, valued at a mere 3% premium now, value stocks have emerged resilient, maintaining a 13% discount to their fair value. This dynamic presents an intriguing opportunity. Our analysts have recognized the need to adjust valuations on many value stocks, enhancing their attractiveness even further.
Optimizing Your Portfolio by Capitalization
Investment strategies by capitalization indicate that small-cap stocks, currently at an 18% discount to fair value, should be overweighted, while large and mid-cap stocks should be underweighted as they trade similarly to the overall market valuation.
Historically, small companies thrive under favorable monetary policies. Morningstar Wealth Management forecasts that the Federal Reserve could cut rates three times this year. Though small-caps remain undervalued now, they may take time to gain traction.
The Downfall of AI Stocks: Beyond Tariffs
Contrary to widespread media beliefs, tariff adjustments are not the primary cause of market declines. John Rekenthaler elaborates in his article, “Tariffs Aren’t the True Cause of the Markets’ Selloff”, explaining that the AI sector’s downturn has played a crucial role. Attributing over 10 stocks for significant negative contributions to the market’s underperformance illustrates the stock prices’ vulnerability that stem from their popularity in the AI craze.
Are AI Stocks in a Bear Market?
The steep drop in AI stocks has extended well beyond a handful of notable names, signaling a broader trend influenced largely by market sentiment and trading patterns. Many peaked before the hype and have since been trending downward since the start of the year.
Wide-Moat Stocks: A Rare Opportunity
After a notable sell-off, large-cap stocks with economic defensiveness—Apple, Alphabet, Amazon, Microsoft, and Nvidia—are now rated as *attractive*, boasting a 7% discount from their intrinsic value. This glide towards historical averages provides a ripe moment for investors to reassess their portfolios.
In a slowing economic environment, companies with sustainable competitive advantages will likely face less downside risk compared to their peers. Reassessing portfolio quality with an eye toward attractive, wide-moat-rated stocks is advisable.
Sector Valuation Changes: Insights and Observations
Across various sectors, we have noted that valuations are converging towards fair value, with communications becoming increasingly undervalued as tech giants falter. Conversely, the consumer cyclical sector has seen significant depreciation largely attributable to Tesla’s** stock downturn.
Notably, despite sector growth in energy and healthcare, the utility sector’s soaring valuation trends suggest an overly optimistic market stance.
Join Us for Our Q2 2025 Market Outlook Webinar
Don’t miss our upcoming webinar on Tuesday, April 8, 2025, at 11 a.m. Central/Noon Eastern! Join myself and Preston Caldwell, Chief US Economist at Morningstar Investment Management, for a deep dive into:
- Valuation breakdowns and potential undervalued opportunities.
- Highlighting long-term growth themes worth investing in.
- Our forecasts for GDP, inflation, and interest rates.
- Live Q&A to address your burning questions!
Register for the session here.
Stay informed and empowered to navigate the ever-evolving stock market landscape!
