We expect volatility to persist in 2026 and recommend balancing undervalued growth stocks with high-quality value stocks.
In this bonus episode of The Morning Filter podcast, co-host and Morningstar chief US market strategist Dave Sekera and Morningstar chief US economist Preston Caldwell share their new outlooks for the market and the economy. Tune in to find out whether the market is undervalued today, which sectors hold the best opportunities, and what stocks make Morningstar analysts’ top picks list. Sekera also explains why he thinks a value-growth barbell strategy can win in 2026 and how to execute it.
Caldwell covers when he expects GDP growth to reaccelerate, why worries about the K-shaped economy are overdone, and how long he thinks it’ll be before the Federal Reserve cuts interest rates again. The episode concludes with a bond-market outlook, including whether the worst is behind the private credit market.
Episode Highlights
Why we think a barbell approach to US stocks make sense today.
Which parts of the US stock market look most undervalued.
Why we expect volatility to persist in 2026.
Morningstar’s updated forecasts for GDP growth, inflation, and interest rates.
Our take on the bond market.
Read about topics from this episode.
33 Undervalued Stocks to Buy in a Volatile Market
Q1 2026 in Review and Q2 Market Outlook
Stock Sector Outlooks: Morningstar’s Top Q2 Picks Across the Market
Got a question for Dave? Send it to themorningfilter@morningstar.com.
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Tune in to The Morning Filter podcast every Monday at 9 am Eastern, 8 am Central. Subscribe to get notified when we post next. Happy Investing!
Susan Dziubinski: Hello, I’m Susan Dziubinski. Welcome to a bonus episode of The Morning Filter podcast. Now, as regular viewers and listeners know, we’re doing some bonus episodes of the podcast covering topics that you’ve told us you want to hear more about. If you have an idea for a bonus episode, send it to us via our email address, which is themorningfilter@morningstar.com. Today’s bonus episode is a replay of Morningstar’s comprehensive second quarter 2026 Stock Market Outlook Webinar, featuring The Morning Filter co-host, Dave Sekera, and Morningstar Chief Economist, Preston Caldwell. Now, after a tumultuous first quarter, Dave and Preston share their outlooks for stocks, bonds, inflation, interest rates, and the economy for the second quarter and beyond. Have a listen.
Before you dive into your prepared remarks, Dave, I want to ask you a few questions after the US-Iran ceasefire that was announced last night. At the start of 2026, in this webinar, you suggested that investors maintain a barbell portfolio to take advantage of volatility in 2026, balancing on one end those high-quality value stocks, including energy stocks, with high growth tech and AI stocks on the other side. During the past couple of weeks on our weekly podcast, The Morning Filter, you’ve been suggesting that investors take some profits and value and energy stocks, and invest those proceeds in undervalued tech and AI stocks. As of right now, which is noon on April 8, US stocks are rallying, and oil prices are falling. How are you thinking about that barbell structure today?
David Sekera: Good afternoon, Susan. I think today, and right now, is an excellent time to do nothing. Right now is a great time to let that barbell strategy work for you. As you mentioned, in the past couple of weeks, we were recommending to take profits; not necessarily selling your entire position, but at least locking in some of those gains on value stocks and specifically energy stocks. As you noted, we’ve been recommending energy stocks throughout all of 2025. They were one of the most undervalued sectors last year, and paid very good dividend yields. We also noted several times that they actually would provide a good natural hedge in your portfolio, just in case inflation were to return or for any other geopolitical issues. Now, I certainly didn’t have on my radar the Iran conflict this year when I was thinking about that, but there were certainly enough other hotspots in the world to warrant that caution.
At this point, as much as oil has fallen, hopefully you’ve taken those profits and put them into some of those other undervalued sectors; specifically growth stocks, which have taken the brunt of the selloff thus far this year, and even more specifically into technology stocks, and more specifically than that, a lot of those AI stocks, which have gotten hit hard. That’s where I see the most upside here today in growth, specifically the technology sector and a lot of those AI stocks. At this point, let that barbell-shaped portfolio work for you. I think you’re going to see the upside there. For the downside, you’re going to see value lag, probably not necessarily sell off, but certainly lag to the upside. I think energy, as we’re seeing it, will continue to sell off as long as oil prices continue to keep falling from here.
Thinking about it by capitalization: Small caps, when I last checked, were slightly outperforming large caps this morning, and small caps, if you notice, will be the most undervalued part of the marketplace, but I think the large caps probably rally the most first over the next couple of weeks. Then, I think you will see the small caps follow up thereafter.
Looking at our sector outlooks, the ones that have been hit the hardest are also the ones that we think are the most undervalued today, specifically the technology sector, the communication sector, and the consumer cyclical sectors. Those are outperforming this morning. We still think that each of those has much further to run to the upside. You’re going to see those less economically sensitive sectors, the defensive sectors, consumer defensive, healthcare, and utilities will lag the upside in some cases, based on their valuations. I actually wouldn’t be surprised to see those fall here in the short term.
Now, what should we be thinking about next? Like anything else, it ain’t over until it’s over. The questions that investors should be thinking for themselves right now are: Will this two-week truce hold? Could we see any kind of reignition in the conflict over the course of these next two weeks? Are we going to get to any kind of negotiated agreement by that deadline, two weeks from now? Hopefully, we will get to some sort of permanent resolution either in these next two weeks or some sort of agreement that can get us there for the long term.
We’ve talked about this on The Morning Filter a number of times over the past month—just how much I’m keeping a close eye on the oil futures contracts; looking at the front month, the second month, but even looking at some of those longer prices as well. Looking at the numbers today, the May 2026 contract is $96 and some change. The last trade date for that contract is April 19. That’s going to be inside the two-week truce date, which I believe will be April 21. But, at $96, as much as that’s even fallen today, that’s still up 47% from where oil was trading in that contract prior to the conflict. Taking a look at the second-month contract for June 2026. Now, the last trade date is May 19. That’s a week before the Memorial Day weekend, which of course is a big driving weekend here in the US. That contract, last I saw, was about $88. That’s still up about 32% from where it was pre-conflict. Lastly, looking further out, the oil futures strip, the December 2026 contract, last I saw, was about $72.5. That’s still up 15% from where it was pre-conflict. I still think a lot of that has yet to roll through.
Thinking about volatility, I still think that there’s going to be a lot of volatility over the course of this year, not only the next couple of weeks and months, but really throughout the year. We’ll talk about what some of those key risks to watch for are going to be. I expect over the months ahead, maybe even the next quarter ahead, there’s a lot of production and shipping disruptions that are going to need to work through the global economy and the US economy. We’ve noted on the podcast that there have been some of the commodity-oriented chemical companies, in Asia specifically, that have shut down production. A lot of those chemicals go into plastics and a lot of other products out there.
I think those disruptions will end up having some issues before they get back online to where they need to be. No matter how you measure inflation, I expect that inflation metrics are going to be going up here in the short term as those high oil prices work through the system; not just in gasoline and diesel and the cost of shipping, but we’ve also seen an increase in soybeans, wheat, corn, a lot of those agricultural products, which require large amounts of fertilizer, coming mostly from natural gas. Natural gas has also been shut off to some degree, so I know the fertilizer prices have been going up as well. We’ll see how much consumer retrenchment there is. I know when I talked to Erin, the sector director for our consumer team, she didn’t really think there would be too much change in consumer habits unless oil prices remained high through the Memorial Day weekend and into the summer. Hopefully, we won’t see too much pullback in the consumer over the second half of the year. Of course, then we still have all of the risks that we talked about at the beginning of 2026 that I still think could work their way through the system over the course of this year.
Dziubinski: All right, Dave. You pretty much covered all my questions. Why don’t you move on to your prepared remarks about your second quarter outlook?
Sekera: Because we’ve changed things up here in a little bit at the beginning of the webinar, I’m going to fly through a couple of these slides more quickly than I otherwise would, because I really want to get to Preston’s economic outlook, so he has enough time to flesh through that because I know we’re going to get a lot of questions on the economy and inflation. I’m going to quickly review the equity market valuation, highlight our sector valuations in top picks, valuations by economic moat, and then highlight what’s going on with a lot of the different mega-cap stocks. I’ll turn it over to Preston to give his economic outlook, and then I’ll wrap things up with a quick fixed income outlook. We’ll leave as much time as we can for Q&A at the end.
Taking a look at the market: When we ran our numbers, the market was trading overall at a 12% discount to our fair values. For those of you that haven’t attended our webinars in the past, the way that we look at fair value is going to be very different than what you hear from a lot of other market strategists. Over the course of my career, I’ve always found that market strategists typically have some way to predict S&P 500 earnings for the year. Some sort of model, algorithm, or economic model, and then they’ll apply some sort of forward multiple to that. It always seems like they’re telling you that the market’s 8% to 10% undervalued based on whatever forward PE multiple they use. It always seems to be much more of an exercise in goal seeking than necessarily a true valuation analysis. Morningstar covers over 1,600 companies globally, of which over 700 of those stocks trade on US exchanges. We put together a composite of the intrinsic valuation of all of those stocks, and we’ll compare that to the market capitalization where they’re trading, and that gives us our price to fair value metric, which you see in the Morningstar Style Box here.
As you noted, we did recommend at the beginning of the year that investors should create a barbell portfolio of those high-quality, wide moat value stocks—specifically a lot of those in the energy sector—but then balance that with the high-growth technology and AI stocks. The thought process here was: Since we were expecting a lot of volatility this year, if we had a lot of upside volatility, growth stocks, technology stocks—specifically AI—would outpace the market to the upside. As they ran further and further ahead into fully valued, if not potentially overvalued territory, you could take profits in those and reinvest those into the wide moat value stocks that were undervalued to be able to then readjust the portfolio. Of course, then, the downside in what we’ve seen here is that value stocks have actually performed pretty well through the end of the quarter.
They were in the green, whereas those growth categories really fell the furthest and the hardest. Over the past couple of weeks, we have been recommending taking profits. Take the profits on the energy sector, and use that to reinvest in a lot of these growth and tech stocks that have fallen. Looking forward, you can see that the large-cap stocks have fallen enough that they’re also getting into a very attractive territory, but those small-cap stocks at that 17% discount are still the most undervalued part of the marketplace. A lot of people always ask, how have our price/fair values kind of worked over the long term? This is a chart of those price/fair values going back to the end of 2010 and the beginning of 2011. While this isn’t necessarily a great timing tool, I think it’s a very good valuation tool.
You can see how much the market had fallen, and how quickly it had fallen. Now, I did hold my market weight recommendation through this downturn. In some cases, at the beginning, maybe I should have gone to more of an underweight, but again, we didn’t necessarily see the reason to move away from that market weight recommendation, and of course, bottoming out at this 12% discount. Based on the market movement today, I think we’re probably a 9% to 10% discount overall. But, you can see other periods of time that we think the market sometimes acts like a pendulum, sometimes swinging too far to the upside. For example, at the end of 2021, we thought the market was overvalued.
In our 2022 outlook, we noted a lot of reasons why to go to an underweight at that point in time. At the beginning of that year, we noted that stocks were trading at a relatively high premium to our fair values; at that point, it was a 6% premium over fair value. We also noted in our outlook that we thought inflation was going to be rising. We thought the Fed was going to be tightening. We were looking for the economy to soften. As that all played out over the course of the year, the stocks not only fell, but fell way too far, getting to that really, really deep discount in October of 2022 before the market bottomed out and started its rally back. You can see other instances where the market has acted like that—the biggest discount going back through 2011 during the European sovereign debt and the banking crisis in Europe.
I’m going to skip through a lot of the historical context here. We all kind of know what’s happened over the past quarter. Here’s how the market has shifted from coming into the year through March 23, using the Morningstar style box.
As you would expect, it was these sectors most closely tied to oil that have done the best. Again, energy stocks—huge rip roaring rally in the first half of the year. Some of these other sectors, the more economically sensitive ones, have performed the worst—technology again, with AI stocks really falling hard, as one of the worst-performing sectors. But, financial services was one of the sectors that was either the most or second most overvalued coming into the year, and was one that got hit one of the hardest over the course of this year. We think, to some degree, the market was pricing in too much interest income, net interest income growth over the course of the year, looking for those NIM margins to expand. As short-term rates came up and the curve flattened to some degree, that really hit that sector. Of course, consumer cyclicals were really taking the brunt of it, as far as higher oil prices damaging the consumer.
Just looking at the biggest attributes, those that contributed the most to the return for the quarter, was an odd mix in my view. Of course, we had a number of the energy stocks being some of the largest contributors to the marketplace—Exxon XOM, Chevron CVX, and so forth. We also had a number of different, what I call, commodity-oriented tech hardware companies. What we’re seeing with Micron MU and SanDisk SNDK, which provide memory storage for semi chips, for the GPUs that are needed to build out all the data centers, there’s a huge shortage for those memory chips. They’ve been able to raise prices multiple times over the course. They are now at peak margins, so those stocks have rallied very hard. As you’ll see, we think those have rallied too far to the upside. With the huge demand for these AI semiconductors, AMAT, LRCX, and a number of other stocks that provide the equipment that’s used to be able to manufacture those AI chips, those stocks have also done very well. Anything tied to data center demand growth and building out those DCs has done very well—stocks like GE Vernova GEV and Caterpillar CAT. Lastly is some of these really high-quality value names, Johnson & Johnson JNJ, Caterpillar, that have done very well as people had that flight to safety bid.
Just going to walk through here, where our star ratings are at the beginning of the year versus now, versus our changes in fair value at the same time period. Also, I just want to highlight who the biggest detractors were over the course of the year. Stocks like Microsoft MSFT, Apple AAPL, Nvidia NVDA, Amazon AMZN, Tesla TSLA, just kind of rolling down the list here of some of the largest of the mega-cap names. A lot of these stocks tied to artificial intelligence have sold off. In this case, I’d note that Microsoft, also being tied to software, has sold off. So, a big selloff in the software stocks over the course of the year, just as people get more and more concerned about what might happen to the software sector specifically, and what kind of disruption or displacement you might see in software, as compared to the rise of artificial intelligence. Then, a couple of these others that had sold off—JP Morgan JPM, unfortunately, hasn’t sold off quite enough to get to be a 4-star stock yet, but at least it’s moved out of 2-star into a 3-star range. Again, with short-term rates rising as much as they have, we’ve seen a big correction in the financials. You can look at this at your leisure, but taking a look at what we’ve done with our fair values over the course of the quarter, as compared to the market changes, and how much of these now are starting to look more and more attractive as 5-star and 4-star-rated stocks.
We’ve talked about this for several years now about how undervalued value stocks were compared to the rest of the marketplace. Of course, over the past couple of years, it’s all been about artificial intelligence, and AI stocks leading the market to the upside. Those, of course, are in the growth category. We saw value underperform quite significantly for a number of years in a row, but on a historical basis, we were showing just how undervalued they were compared to the broad market. That corrected very quickly to the upside to the point that now, value stocks are actually on a relative value basis, trading above the broad market. That’s part of the reason over the past couple of weeks why we’ve been telling investors that now is a good time to take profits in a lot of those value stocks to then be able to reinvest back into the growth category.
Lastly, looking at a similar chart that shows how small-cap evaluations have compared to the broad market valuation. You can see in 2020 and 2021, back when the stock market was rallying to the upside, everyone was looking at disruptive technology stocks. A lot of those small-cap disruptive technology stocks really soared way too high in many cases, well into 1-star territory, only to then correct during the 2022 sell-off. We’ve really seen small-cap stocks not necessarily trade up that much faster than the market over the past quarter or so, but they’ve held their value better to the downside. To some degree, I think this just shows that the marketplace does see the value now in the value category, and it was the large-cap stocks that took the biggest hits during this sell-off.
As far as what 2026 still has ahead of us, we shall see how things play out here over the next couple of weeks. One of the biggest risks, and I’ll certainly let Preston talk about this a lot more in his section, but depending on how high oil prices stay and for how long, whether or not that could lead to any kind of stagflationary environment, we could see a slowing rate of economic growth slow even further if oil prices were to stay that high. Of course, we’re going to have higher than expected inflation here, at least for the next couple of months, as the high prices roll through. We’ll look to see what oil does in the months ahead to see if that’s going to come down in the second half of the year. What we’ve noted before with AI stocks is that they do require even greater growth to support the very high valuations that we see. We see a lot of value in those stocks as compared to our base case. A lot of them, like Nvidia, are 4-star-rated stocks. From what I notice, what’s going on in the marketplace with a lot of those stocks is that the market has already incorporated into their valuation growth for 2026, and in fact, even the amount of growth for 2027, but I think the market is really looking for more proof that it can continue to keep growing in 2028 and thereafter.
I think the market is looking for specific examples as far as how AI is going to generate new revenue growth for these companies, and also looking for the evidence that AI will be able to improve productivity and efficiency at these companies in order to help support operating margins going forward as well. Of course, we’ve got a new chair coming in, taking the reins at the Fed. We’ve got midterm elections this year. All of that could throw some wrenches into the marketplace as well. To some degree, probably this summer, I would expect a resumption of the trade and tariff negotiations, specifically between the US and China. We’ll see how that plays through. We’ve noted this for a couple of quarters: Morningstar DBRS, the credit rating agency subsidiary of Morningstar that rates a lot of these private credits, has noted for several quarters now that they’ve seen fundamental weakening in the credit ratings that they have outstanding, that these companies have been in an environment where interest coverage is getting lower, debt leverage has been increasing.
They’ve been downgrading more of them than they’ve been upgrading. They’ve noted that a lot of these have gotten weak enough that they’ve required wet waivers because they’ve been breaking their covenant levels. Some of them have gotten weak enough that they’ve required new capital injections from the private equity sponsors to keep them from going into bankruptcy. They’re also seeing a higher increase in the number of defaults, where a lot of these companies are doing these negotiated exchanges outside of bankruptcy court in order to keep the company up and alive, but they are still seeing haircuts in the principal amounts of those private credit deals. The Chinese economy, we’ll see how that goes. I think the risk there is that it could be weaker than expected, or at least a deceleration, accelerating in how fast their GDP is decelerating. It’s still in the green, but it does look like it’s decelerating at this point.
As we’ve talked about a couple of times, I keep a very close eye on the Japanese government bond market and the Japanese yen. Really concerned that if those weaken too much too fast, that could lead to an unwind of the carry trade. JGBs have been doing better this morning, so yields have been coming back down from some of their highs. Japanese yen is also doing better today, but is still close to 160 to the dollar. I’d like to see that recover even more before I am not as worried about the Japanese markets.
Just looking quickly here through our valuations, we provide this chart every quarter. We can just see that with the market to sell off, we’re seeing a higher percentage of the number of companies that we cover in total. Now, in that 4-star and 5-star category, this was much lower last quarter. You can also see which of these quarters we have a higher percentage by number of stocks of 4- and 5-star stocks, and a lot fewer 2-star and 1-star-rated stocks. This is just a heat map by market capitalization, showing the valuations for each of the individual sectors. Technology, the largest sector by far by market cap, having fallen enough. It’s at about a 23% discount to fair value. That’s one of the biggest discounts in fair value that we’ve seen in technology over probably the past 15 years. A lot of these other sectors, like the financial sector, were overvalued last sector. It’s now starting to get into undervalued territory. The consumer cyclicals have fallen enough that they’re now looking attractive here as well, but still a number of sectors that we do think are overvalued: industrials, consumer defensive, and energy at this point. Energy has skyrocketed; it’s up 35% or more over the past quarter. That’s gone from being one of the most undervalued to now being one of the most overvalued. Of course, the utility sector, great growth. Yes, there’s going to be a big increase in demand for electricity over the next couple of years as those data centers get built out. AI chips require multiple times more electricity and power than traditional chips, but we think that to some degree the market’s gotten ahead of its skis here. We are modeling that into our growth estimates for the utility sector, but we still think that, for the most part, a lot of these utility names have run too far, too fast.
Just running through the valuations on a couple of the different sectors here. In tech, some of the big names that we find very undervalued today are Nvidia, Microsoft, Broadcom AVGO, and communications; it’s mostly about Meta META at this point in time, but even Alphabet GOOGL has fallen enough that it’s looking more attractive. Even traditional communications names like T-Mobile TMUS are looking especially attractive to us today. Some of the same names we’ve talked about in the real estate sector still look attractive; AMT, that’s a cell phone tower, REIT, looks attractive to us, Realty Income O. Again, another sector, triple net lease provider, that looks attractive. Public Storage PSA is another good one as well.
Consumer cyclical: We’ve got to highlight Amazon, and in this case, Chipotle CMG. Chipotle is an interesting one. This is a stock that, it wasn’t that many quarters ago, we were warning investors that we thought it was overvalued. It’s fallen enough that it’s starting to look attractive to us here. The energy sector: Very few undervalued stocks are left in this sector. Everything has rallied. This is one of those times you had it in your portfolio as a hedge against inflation and against geopolitical issues. That hedge has worked. That’s when you need to start taking some of the profits. You’ve got to lock in those gains because again, when things turn around and they fall, you don’t really want to end up right back at the same place that you started with. That’s why we’ve been recommending for the past two weeks now to at least lock in some of the profits in that sector.
Consumer defensive: Still a barbell there, in that we think some of the names like Walmart WMT and Costco COST are significantly overvalued because there’s such a large percentage of the market cap of that sector that skews the entire sector up. Here, we would just say to stick with a lot of the consumer packaged group food names. We think a lot of those are very undervalued. Utilities: The only thing that’s really left are story stocks, so I’d say those that are undervalued in the utility sector, just beware. A lot of those are ones that I would say you really need to read through the analyst write-ups to understand what the risks are in those names. They’re very idiosyncratic in why we think that they’re undervalued. Lastly, with industrials: Again, we’ve been recommending here to take profits on. Some of those names, like the defense names that have done very well this past quarter, are stocks that we’ve been recommending for the past two years, but at least lock in some of those gains at this point. A lot of the ones that are tied to the AI buildout, again, a huge amount of growth there, but we think the market’s just overextrapolating with some of those AI buildout names.
As far as our best picks, a number of new best picks here, so I’ve highlighted those. I bolded those so you can quickly spot them. In the interest of time, I’m going to walk through these slides because I really do want to give Preston enough time to go through his economic outlook.
Interestingly, by quality, a lot of this stuff all ended up falling at the same rate. If you look at the valuations for no moat versus narrow moat versus wide moat stocks, these are all in relation to one another, very similar on a relative value basis compared to where they were last quarter. That just tells me it is a very good opportunity to upgrade into those wide-moat names, specifically, wide-moat small-cap names. I think there’s a lot of great swap opportunities out there. You can use a couple of different types of Morningstar screening tools, looking for those no-moat growth names that are significantly overvalued, and then being able to take the principle and rolling that into undervalued wide-moat growth stocks.
Just running through some of the wide moat stocks with low and medium uncertainties. This is just a rank order of the price to fair value from some of the most undervalued stocks on up. Danaher DHR is one that I know we just recently added to our best ideas list. I think now’s a good time to be taking a look at that one. Microsoft, I still think that’s a core stock that you should have in pretty much any portfolio. That stock has really taken a beating this past quarter. I think now is a good time to dollar cost average into larger positions there. Again, a similar run looking at undervalued mid-cap stocks, those with wide economic moats, low and medium uncertainty ratings, and then lastly, the small-cap universe.
This is a heat map, taking a look at those stocks that we cover by market capitalization, by the star rating. You can see here some of the big names like Nvidia, Amazon, Microsoft, Broadcom, Meta, all trading in undervalued territory. Microsoft has a 5-star rating. Not often have you seen that company over the past 15 years trade with a 5-star rating. Some individual large-cap names: Walmart, Costco, and J&J. J&J is one that we’d recommended years ago as being a core holding for most portfolios. It’s just that at this point in time, it’s run too far to the upside. When you run into that 2-star and 1-star territory, there’s nothing wrong with taking a little bit of profit off the table. You can still keep a percentage holding in a name like that and then just wait for a name like that to correct, and then you can go ahead and kind of get back to whatever your full position size is.
We covered this ad nauseam last quarter, talking about how concentrated the market has become with the large 10 mega-cap stocks becoming an increasingly larger percentage of the market. What we saw over the past quarter is that some of those same stocks, which have been the big growth drivers of the market overall for the past couple of years, did sell off more than the rest of the market because we did see a lot of diversification in how returns worked out over the course of the quarter by sector. If you look at the yellow line, you see a little bit of a retrenchment here as far as a selloff in the mega-cap stocks, and it brought that percentage down, but still a much higher percentage than it’s been going back over the past 15 years. Similar chart, but again, just showing it, looking at a stock line chart.
Lastly, reviewing how undervalued mega-cap stocks have performed over the course of the quarter. Some of these, like Nvidia, are looking more attractive. Microsoft is more attractive, but also looking at some of our fair value changes. Some of them, like Oracle ORCL, we did pull our fair value back there by over 20%. Salesforce CRM, we did reduce our fair value there by a little bit as well, but something like Salesforce in the software sector is still one that I think looks very attractive to investors. The overvalued mega-caps, interestingly, to some degree, some of these actually performed relatively well to the downside. Some of the expensive stocks got even more expensive over the course of the quarter, but you also have to look at that in relation to what we’ve changed in our fair value. Something like Micron is up 42%, but we doubled our fair value on that one just because that shortage in those memory-oriented semiconductors really led to a huge boom in earnings in that sector.
Looking at the updated list of undervalued mega-caps, so a couple of new names on here, like Bank of America BAC. If you’re looking for something in the financial sector, that’s one that’s undervalued today. Something with a wide moat, low uncertainty, good dividend yield, consumer defensive, PepsiCo PEP, I think that’s another one to take a look at today. As far as the overvalued mega-cap stocks, a number of new ones are coming into the list here as well. With that, I’m going to turn it over to Preston because I know a lot of people want to hear his economic outlook.
Preston Caldwell: Thank you, Dave. I can confirm there was no earth-shattering news moving the market during your 30 minutes of remarks. Hopefully, I can be as lucky. First off, I want to point out that the numbers I’m going to share haven’t been updated, of course, for last night’s ceasefire announcement, but I’ll do my best to preview the impact on our forecast. We’re forecasting GDP growth to remain a little bit slower than it’s been in the recent past. We averaged 2.8% over the 2022-24 period, and that fell to 2.1% in 2025. Now, a lot of that 2025 slowdown was due to one-off factors. The federal job layoffs, the government shut down in the fourth quarter, and the jump in imports at the beginning of the year to try to beat tariffs. In light of that, you might expect GDP growth to bounce back this year and the next, but that’s not what we expect because there’s some lingering headwinds and some new ones coming into play. Tariffs are still a factor. There’s obviously the oil price shock, and low population growth is cresting an impact.
We’ve got the impact of some fading of the asset price boom owing to AI, and also the accompanying slowing in investment expenditure related to AI, and that weighing on growth. Nonetheless, we do expect growth to rebound in the later years of our forecast. Some of the headwinds I just mentioned should reverse course. In particular, we expect a good deal of further monetary policy loosening because if we do dig into the data, we do see that high interest rates have weighed on aggregate demand in the US. It’s just that that’s been offset by other factors, especially in recent years, the AI boom. Turning to inflation, our forecast is that PCE inflation rises to 3.3% in 2026, up around 0.7 percentage points from 2025. Now, this was published a week ago, and oil prices increased substantially after that, up until last night’s ceasefire announcement, which is to say that the impact with respect to our current forecast isn’t as large as you would think, just looking at the 15% plunge in oil prices that just occurred. Based on this morning’s futures prices, we’d subtract around 15 basis points from the inflation impact of oil prices in 2026, but that would still leave us with inflation at about 3.1% in 2026 on average; still a major spike, and qualitatively, the story remains much the same. Now, we do expect inflation to fall after 2026 as the oil price shock unwinds and the tariff impact is fully played out. By that time, there will also be additional slack in the economy, given the slower rate of GDP growth, which will put further downward pressure on inflation.
One major update to our forecast comes from population, and so the shift in immigration policy has been more restrictive than we anticipated, particularly at the outset of the second Trump administration. We’ve lowered our population growth forecast to an average 0.28% over the next five years, which is obviously dramatically lower than the recent spike over 2023 to 2024, but it’s even a full half a percentage point lower than what we averaged during the 2010s. So, what’s the impact of this? Obviously, there’s a downward impact on GDP growth because immigration simultaneously boosts the demand on the supply side of the economy, but not so much of a net impact on inflation because those demand and supply shocks offset each other when it comes to that. In terms of interest rates, I do think that immigration does affect the natural rate of interest because it does affect the trend growth rate in the population.
To make this a little bit more concrete, I think the strong population growth that we saw over the last several years was one major factor that was helping prop up housing markets in spite of very high interest rates. Now that we see that move in the opposite direction, population growth has slowed. I think that’s part of the reason why we’re seeing renewed downturn in residential investment, even though we’re well over three years after we reached peak mortgage rates.
Going into the expenditure forecast in a little bit more detail, GDP by expenditure. As I mentioned, in 2025, net exports weighed on GDP growth, and so that’s likely to flip in the opposite direction in 2026. Just taking that alone, we’d expect a 50 basis point boost to GDP growth in 2026, but you can see that’s offset by slowing consumption growth. The reason why we expect consumption growth to slow is due to a few different factors. Population, as I mentioned, but also asset price appreciation, even if we don’t see a major market selloff, asset price appreciation is likely to be considerably weaker than we’ve seen in the last several years on average. That’s going to fuel less in the way of consumption growth than it did previously.
Going into 2027 is when we expect a slowdown in private fixed investment. The reason why that is, if we look at investment right now, it’s been the case that over the past year, that AI fuel investment has soared. Broadly, high-tech related private fixed investment was up 11.1% in 2025, but if we look at all other non-residential investment, it decreased by 2.7% in 2025. Of course, residential investment was also down in 2025. Outside of tech-related categories, virtually all private fixed investment was in contraction in 2025, which I think reflects the lingering effects of high interest rates. Until we get further monetary policy loosening, which I don’t expect until 2027 and 2028, I don’t expect a recovery in those other non-tech categories. Also, I think we’re likely to see a slowing in the rate of AI-related investment in 2027, even if it looks like in 2026, we’re going to plow ahead with another record-breaking year of very strong growth.
Looking at GDP growth from a supply side perspective, just a few things to point out here. Productivity growth has been very strong. It’s averaged 1.9% since the pandemic. That began well in advance of the mass adoption of generative AI. I think AI has become a contributing factor in sustaining this productivity boom, but it’s probably not the main factor. Now, this high productivity growth, just from an accounting perspective, explains why we’ve had strong GDP growth despite very meager job growth recently. Obviously, if productivity growth is near 2%, then you can have seemingly robust GDP growth figures, even if job growth is nearly zero.
What does this mean for the labor markets? Is there slack accumulating in the labor markets right now, because we know labor supply has contracted? Based on the population growth forecast that I just shared, I think that breakeven job growth is about 0.35% in 2026, which is quite low, but we’re forecasting actual job growth to be 0.15%, 20 basis points lower this year. That means we do expect, even though there is a contraction in labor supply, the contraction and labor demand is even somewhat larger, and we do expect the unemployment rate to continue to creep upwards at a slow rate. We expected to reach a peak of 4.6% in 2027, up from 4.3% in 2025. Decently above its natural rate, about a hundred basis points above its natural rate, in our view. That’s going to continue to weigh on wage growth in our view, which has continued to decelerate and help to provide some further disinflationary pressure, as well as ultimately tip the Fed back to cutting, once this oil price shock recedes.
We recently tackled this topic of the K-shaped economy, and I just want to share a few key takeaways, but I encourage you to check out our economic outlook for the full details. Based on our findings, there’s been a modest amount of excess consumption growth among the highest income households in the last several years. If we look over the full period since the pandemic, households in the top decile saw their consumption grow about 1.1 percentage points faster than the average over that period. If we just look at the last three years, that’s 2.5% in excess growth, but it’s not the case that low and middle-income households’ consumption growth has ceased entirely based on the data. Now, that excess consumption growth among high income households is well explained, partly by the excess growth in their personal income due to capital income slightly outperforming labor, the growth and labor income, but also because their savings rate has dipped more; high-income households have decreased their savings rate to a greater degree as they’re seeking to pull forward the wealth that’s been recognized in the run up and asset prices.
Now, at the same time, lower-income households, particularly in that zero to 60th percentile bucket, still have a substantial stockpile of excess savings by our reckoning. What that largely represents is a lower rate of debt accumulation compared to pre-pandemic trends. So, we look, and we see that aggregate household debt as a share of GDP is down around 7 percentage points since 2019. By our calculations, that’s attributable to a great degree to lower-income households. Even though we do see some signs of rising delinquencies affecting perhaps a minority of households, it looks like, in aggregate, that leverage has come down since before the pandemic. When we talk about this K-shaped narrative, it’s important not to draw any kind of allusions to the situation in the mid 2000s housing boom, where households across the income spectrum were in a much more vulnerable financial situation.
Turning to inflation, we saw housing inflation plummet in 2025 and also continue in 2026. In 2025, that was offset by the increase in goods price inflation driven by tariffs. That’s why inflation remained flat in 2025 versus 2024. Now in 2026, we expect to see continued acceleration in goods price inflation from the impact of tariffs, as well as the impact of this energy price shock. Looking forward, we ultimately expect inflation to recede as housing inflation remains low and these price shocks from tariffs and energy prices roll off. We also ultimately expect this other category, which is core services—excluding housing, the green line on this chart—to recede owing to the slack in the labor market and the downward pressure on wage growth that I mentioned.
This chart shows the contribution of oil to overall PCE inflation over the last half-century. As I mentioned, the 2026 observation, if we factored in this morning’s futures prices, would be about 0.5% in impact rather than the 0.65% that you see on the chart. Regardless though, the one thing I wanted to point out is that it’s substantially lower than the impact that we saw during the 1970s, during the great inflation of that era, mainly because if we look at oil as a share of personal consumption, it’s fallen to around 3% of the consumption basket as of 2025, less than one half of its average in the 1970s, which was over 8%. Oil is much less important to the consumption basket to the overall economy than it was back then. That rules out some of the worst-case scenarios and some of the analogies that people draw to the 1970s when it comes to this oil price shock.
On tariffs, the one thing that I’ll observe here is that we don’t expect a major reduction in the average tariff rate in 2026 compared to 2025. After the Supreme Court’s IEEPA ruling, the stated tariff rate dropped by around 4 percentage points, but the actual tariff rate, accounting for substitution effects and compliance gaps and whatnot, probably will only drop by about 2.5 percentage points. When we look at things on an annual average, there’s really not much of a decrease in 2026 overall. We’re going to have to wait for later years to see more of a relief on the tariff front. Meanwhile, there’s still quite a bit of room for businesses to pass through tariff costs on to consumers because only a minority of those costs have been passed through so far.
We’re expecting the Fed to pause rate cuts in 2026. As of this morning, it looks like futures markets are still pricing in the same. The probability of a rate cut has risen, but it’s still the median scenario is still that we get no rate cuts in 2026, and I think that’s appropriate given where oil prices are, and what the futures curve is showing at the moment. However, we do expect rate cuts to resume in 2027 and 2028, with another five cuts cumulatively by the end of 2028 or 1.25 percentage points in rate cuts. That’ll get us down to a target range of 2.25% to 2.5% for the federal funds rate, considerably closer to the pre-pandemic average. In turn, that will push longer interest rates down further. We expect the 10-year treasury yield to drop to an average 3.25% by 2029, down from its 2025 average of 4.3%, and also the 30-year mortgage rate to drop to 5%.
So, both of those two longer-term rates are dropping by over a percentage point compared to current levels. That should be needed to continue to stimulate a healthy amount of economic growth. In particular, the housing market will ultimately need a lower mortgage rate in order to sustain a decent rate of growth. Home buyers have been placated by this notion for so long that they can refinance at lower rates despite very high mortgage rates right now, and eventually that hope will have to materialize. I think that story is similar in other interest rate-sensitive sectors of the economy. So with that, I’m going to go ahead and pass it back over to Dave. Thank you.
Sekera: Great. Thank you very much, Preston. All right. We’ve got a lot of questions coming in. I’m going to just kind of walk through the fixed income outlook here very quickly, just taking a look at the shape of the yield curve, how it’s flattened in that two-year space, where it’s flattened the most. The US core bond index contracted almost 20 basis points through March 23. Again, a tough year struggling with interest rates going up, pushing bond prices down, and then also seeing what’s going on with the corporate bond markets. Over the past, call it a couple of months, we have seen credit spreads widen out. The corporate bond index, which is our proxy for the investment-grade bond market, did widen 8 basis points to 85. Little widening in the high yield market, 40 basis points to 315.
The private credit market has definitely been experiencing a lot of weakness thus far this year. We’ve seen a lot of the alternative asset manager stocks get hit very hard. My view is that I still think we have a lot of losses in private credit yet to come. I do have a link in here for those of you that have an interest in private credit. The link here is going to take you to dbrs.morningstar.com. From there, you can find our private credit page. You can register for free online and start getting some of the research that they’ve been putting out over the past year on private credit. Again, when you look at corporate credit spreads, you look at where they are today compared to where they’ve been over the past 25 years, you still see we’re bouncing around some of the historically tightest levels that we’ve ever had. I don’t have much interest in investment-grade or high-yield at this point.
I still think that there’s more downside risk than upside potential to some degree with both of these markets here in kind of that “picking up pennies in front of a steamroller” stage, where if the economy continues to muddle along or do slightly better, yes, you can get your spread here, but for your fixed income portfolio, I much prefer US treasuries; maybe some of the asset backs, or other areas where you can get some spread other than corporate bonds. My concern here is that in any kind of economic weakening environment, especially if you have a bigger blowup in the private credit market, you could see these spread gaps out very quickly.
Dziubinski: We hope you enjoyed the webinar, and we hope you’ll join Dave and I on The Morning Filter podcast every Monday at 9 a.m. Eastern, 8 a.m. Central. Happy investing.