Opportunities in Q2 Stock Market Outlook
The current Q2 2025 market outlook points to a bear market in artificial intelligence (AI) stocks, resulting in more appealing valuations, especially in the value and wide-moat stock sectors. As highlighted in the 2025 Market Outlook, the market was previously priced at a premium but has since undergone a shift, with value stocks proving to be attractively priced compared to growth stocks that are overvalued.
On a year-to-date basis through March 24, the Morningstar US Market Index faced a decline of 1.74%. Notably, the selloff was most pronounced among AI-related stocks, predominantly found in the growth and core sectors. Conversely, undervalued value stocks managed to maintain their value and even saw an increase of 4.59%.
Valuations across the board have decreased, positioning the US equity market at a 5% discount to fair value estimates. This places the market at the lower end of the fairly valued range, offering potential upside for investors. Even though value stocks have outperformed, they remain undervalued at a 13% discount, while growth stocks, after the recent selloff, are now trading at a 3% premium.
In the current landscape, an overweight position in value stocks, with their 13% discount to fair value, is recommended, while a market-weight position in core stocks is advised due to their slight discount. Conversely, an underweight stance on growth stocks is proposed given their 3% premium valuation compared to fair value estimates.
Regarding market capitalization, small-cap stocks exhibit an 18% discounted valuation, making them an attractive investment option. However, the optimal performance of small-cap stocks is often seen in the presence of a more accommodative monetary policy and declining interest rates, which currently do not align with the economic climate. While small-cap stocks are undervalued, it may take time before they see significant growth.
Despite media suggestions that tariffs may have fueled the market selloff, Morningstar’s analysis indicates that AI stock fluctuations were a primary driver of the downturn. This attribution analysis reveals that the negative return contribution from a select group of stocks outweighed the overall market decline, emphasizing the impact of sector-specific factors.
As the market undergoes significant shifts, investors are advised to calibrate their portfolios accordingly, giving preference to value and small-cap stocks, which present attractive valuations. Remaining vigilant to market developments and economic indicators will be crucial in navigating the evolving investment landscape to capitalize on emerging opportunities.