Where the Stock Market May Be Heading Next and What to Buy Now

[00:00:00] Susan Jabinski: Hello, I'm Susan Jabinski. Welcome to a bonus episode of the Morning Filter podcast. As regular viewers and listeners know, we're dropping 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 themorningfilteratmorningstar.com. Today's bonus episode is a replay of Morningstar's comprehensive third quarter 2026 Stock Market Outlook webinar. The webinar features the Morning Filter co-host Dave Sequeira and Morningstar Chief Economist Preston Caldwell. After a volatile first half for U.S. stocks, Dave and Preston share their outlooks for stocks, bonds, inflation, interest rates, and the economy for the rest of the year. This presentation was taped on July 15, 2026. All right, Dave, I'll turn things over to you now. [00:01:15] Dave Sequeira: Great. Thank you, Susan. And good afternoon. And thank you, everyone, for joining us here. So as usual, just go through our agenda. I'll just start off with the U.S. equity market valuation, you know, where we are today, highlight what's going on with the sectors, where we see our undervalued opportunities and some to steer clear of that are overvalued, highlight a couple of top picks. We'll review evaluation by economic moat. I'll then turn it over to Preston to provide his U.S. economic outlook. I'll highlight what's going on with mega caps. We'll do a quick fixed income outlook and then get to the Q&A. So let's just go ahead and get right into it. So where are we today? So as of June 30th, the U.S. equity market was trading at an 8% discount to our fair value estimates. For those of you that might be new to joining our webinar and don't necessarily understand what that price to fair value metric is, we have a different way of how we look at market valuation than what you'd hear from a lot of other market strategists. Seems to me that most market strategists start off with some sort of estimate of what they think S&P 500 earnings are going to be, they apply some sort of forward multiple to that, and then they get to a number which it always seems like they're telling you that the market's 8% to 10% undervalued. So in my mind, that always really felt like more of an exercise in goal-seeking than necessarily a true valuation analysis. In our case, we cover over 1,600 stocks globally, of which over 700 of them trade on U.S. exchanges. So we take the valuations on those companies as assigned by our equity analysts, and we'll put together a composite of the market capitalization of all those companies where they're trading in the marketplace, and divide that by a composite of the intrinsic valuation of those companies. And that's our price to fair value metric. So in this case, 0.92, meaning the market's trading at an 8% discount. Now, I'd note that broadly saying, you know, by style, valuations are pretty broadly balanced. Really not that much of a difference between where value, core, and growth stocks are trading at this point. So in my mind, I think now is a good time to also be broadly balanced across your own portfolio, essentially having a market weight or a third percent position in each one of those individual styles. When we look in the market by capitalization, small cap stocks still at a 15% discount to fair value. So even after the good rally that they've had thus far this year, that's still the most undervalued part of the marketplace. And we have one outlier this quarter, and that's going to be the mid-cap growth category. And we'll talk about it a little bit later when we go into what's going on with, you know, the different sectors and how things are trading in some of the individual stocks. But I would just note that that's the category that you're going to see a lot of those commodity oriented technology hardware stocks, those that have skyrocketed, you know, over the past year to date, even over the past, you know, 52 weeks into areas that generally I would say are significantly overvalued one and two star rated stocks where we think the market is pricing in too much growth for too long. Yes, there are shortages as the data centers are being built out. But when we consider they our commodity oriented type of, you know, items, and we expect that by 2028, there'll be new supply coming online, you know, we think the market's pricing and growth, you know, further into the future. And so therefore, I think now is a great time to be taking profits in a lot of those different types of stocks. So of course, people always want to know, well, how has that price to fair value metric, you know, compared to the market over time. So in this case, you can see that price to fair value going all the way back to the beginning of 2011. You know, a number of different instances here, you know, where the market was overvalued. I think I was probably one of the few strategists at the beginning of 2022 that had an underweight on equities going into the year. You know, we noted a whole bunch of different reasons why we thought equities were overvalued and we're looking for correction. Then the market does what it often does. Not only did it fall over the course of the year, but then swung way too far to the downside. By October of that year, getting to a very deep discount. In fact, it's trading at much of a discount as we saw during the European sovereign debt and banking crisis in Europe. And then of course, you know, some other areas, you know, here and there, you know, whether it was, you know, during the time of the pandemic when, you know, things had traded off, you know, too far at that point in time. I really can't see it, you know, in the chart here, you know, intra month, you know, the market was trading at, you know, well over 20, if not in this getting close to like a 25% discount. Of course, it, you know, snapped back pretty quickly once the Fed came out with its different plans. So here today, 0.92. So again, it's certainly getting to be more undervalued. In my mind, it's not necessarily enough of a discount from fair value to really move to that overweight and equities as compared to whatever your targeted allocation is within your own portfolio based on your own risk dynamics. So at this point, still think I would market weight the market overall, I would market weight by each of the different styles. And then the only place I probably really look to overweight at this point in time would be the small cap category. Generally, a lot of the risks that we talked about at the beginning of the year that we necessarily highlighted saying why we wanted to have that barbell approach at the beginning of the year, to some degree, a lot of those are still out there, they still need to get work through the system. But I'd say generally, when I think about the risks versus the valuations, where we are now, I think we're much more balanced than where we were at the beginning of the year. Yeah, I just know, you know, a couple of different things, like the market is now pricing in the Fed funds to get increased at least once, if not twice, by the end of the year, you know, inflation, you know, we'll see where we know ends up. But I think the market is also still pricing in inflation generally to be relatively elevated, we did have, you know, the good CPI and PPI numbers, you know, this month, but with the Iranian conflict getting hot again, oil prices, you know, having moved back up to 80, that still will get work through the system. And yeah, that'll get covered by Preston and his inflation outlook. Generally, I'd say the market's looking at the economy being within a range of, you know, 2% plus or minus a half a percent for GDP. Long term interest rates, Preston will give you know, his view as far as kind of the longer term direction of where we think interest rates are going. But for now, I think the market's pretty comfortable with where they are. We've seen them bounce around a little bit. But generally, I think they're going to be range bound in the second half of the year. And then we'll touch a little bit on the fixed income outlook, what's going on in the private credit markets, certainly cracks some smoke that we're seeing in that market hasn't necessarily, you know, broken just yet. But I do think there are a lot of losses that will need to get absorbed in the private credit markets before all is, you know, said and done there. So how have we performed here, you know, in the second quarter, US market was up quite a bit 15 and a half percent, surprise to nobody is really the AI stocks that were driving the returns, the growth category up about 23 and a half percent over the course of the quarter, well outpacing both core and value. And if you start breaking that growth category down, you know, even further and looking at an attribution analysis, the technology sector, you know, accounted for 68% of the growth, you know, within that and even within the core category technology accounted for half of the return there. And the big reason that value lagged so far behind is hampered by the energy sector and the communications sector, both of which were under a lot of pressure in the second quarter after having done well in the first quarter. Taking a look at the large cap category up 15 and a half percent, so in line with that broad market return. But when you do an attribution analysis on the large cap category, I'd note that 70% of that gain came from just nine AI related stocks. And we'll go through those in a few more slides. And then lastly, that mid cap outperformance really driven by those commodity oriented technology stocks, specifically the memory semiconductor stocks, but you know, also networking gear, optical gear, switching, you know, networking gear, and so forth was a big portion of the outperformance there as well. So year to date been a pretty darn good year, I don't think anyone would expected that we'd be up, you know, almost 10.7%, you know, at the mid of the year, considering how poorly the stock market did, you know, in February and March. Again, it's the same story, you know, growth stocks having done very well, tech accounting for 68% of the return for the first half of the year, same as what it was in the second quarter, nine of 10 stocks that contributed, you know, were directly tied to the AI build out boom. And then one thing that I think also surprises here is just how well industrials have done and not just industrials as a sector, but when you get into the sector analysis, it's really those industrial stocks that are going to be mostly tied to the AI data center of build out. So again, names like, you know, GE, Vernova, Caterpillar, you know, really skyrocketed and pulled the industrial sector up, you know, large cap stocks overall did lag a lot of those mega cap stocks that really have been leading the market higher the past couple years, you know, lagged, we saw some other new generals, you know, taking over mid cap, we kind of already reviewed what's going on there. And small caps, you know, up 14% for the first half of the year, it was not only a very good return for small caps, but considering how much small caps have lagged the market, you know, in general, my understanding, that's actually the best first half performance over the past 30 years for small caps, small caps still undervalued. So we see both good momentum as well as good valuation in that part of the marketplace. This slide, to be honest, I'm kind of taking a little bit of a victory lap on this one. And showing my age here, you know, maybe some of you remembered the A-Team, 1980s, you know, sitcom, you know, TV show with the lead character at the end of the show. And the good guys, you know, finally won at the end, always had his, you know, I love it when a plan comes together tagline. And to some degree, that's kind of how the market has worked out based on our valuations thus far this year. So we came into the year at a 4% discount, you know, from fair value. So not that big of a discount, you know, generally, we thought you should be market weight equities based on your own targeted allocations. But at the beginning of the year, we did note a whole host of reasons why we expected volatility to kick up, we highlighted a lot of those specific catalysts that we were looking for. And so to be able to take advantage of that volatility, we were looking at a barbell shaped portfolio. So we recommended to be overweight value, overweight growth, underweight core, and then by capitalization to be overweight, the small cap and then market weight, you know, the mid and the large caps. Big sell off over the course of the first quarter, a lot of downside volatility brought the market down to a more of a discount to that 12% discount from fair value. Usually, I like to see the market, you know, below a 10% or more than a 10%, you know, discount from fair value, before I really start looking for, you know, the overweight and equities, you know, overall. So we're just getting into that area there. But by the end of the first quarter, value stocks actually performed very well, value stocks were up a couple of percent, while core stocks and growth stocks were down a lot. And so coming into the second quarter, you know, we had talked about, you know, moving to that overweight and growth. And not only were we recommending to be overweight growth, but even then we're highlighting the technology sector specifically, and even within the technology sector, highlighting a lot of those high growth AI tech stocks that had sold off the most to the downside. And we're very attractively priced at that point. Quick rebound, April, May and into June, you know, we had a big rebound in the marketplace, value stocks lag behind. And it was really all about growth. So by the end of May, coming into June and our June market outlook, you know, that's when we highlighted it was time to then go ahead, you know, capture a lot of the profits that you got in the growth category, specifically tech and the AI stocks, and move back to more of our market weight position and growth. So at the end of that month, you know, we were looking at a barbell at that point in time. And by now, you know, with as much as core has come down a little bit after we've increased some fair values, I'd say you want to be broadly balanced across value, core and growth. You know, just taking a look at returns, you know, by sector here for the second quarter, you know, all again about technology, you know, the industrial sector doing very well. We did have a pullback in the energy sector. Once the truce with Iran, you know, was announced, we had a big sell off in oil. So no surprise the energy, you know, came down. Again, the industrial sector all about those stocks that are tied specifically to the construction of and powering data centers. So a lot of those stocks have probably moved, you know, too far into the overvalued territory. I'd note when you look at like financials and real estate, I'd say gains were broadly spread out across those sectors. Whereas if you look at like, you know, communications and healthcare, it was much more concentrated in the types of returns that you saw there. And then for the first half of the year, I think a lot of people would be surprised looking that industrial gains were, you know, the top performing sector even above technology for the first half of the year. Again, it's all about the data centers, the electric generation, you know, the stocks in the industrial sector that are specifically tied to that. Other than that, technology, you know, we've covered that, you know, ad nauseum as well. The only thing I'd note with the technology sector is there has been a shift in which of those stocks have been performing, you know, the best. So for the past couple of years, it's all been about the technology leaders, you know, the invidias of the world, really being the ones that drove the technology sector, we did see a shift in the first half of this year that the technology stocks that have done the best were actually no moat stocks, stocks of those commodity oriented hardware companies, those that we don't think have long term durable competitive advantages. But because there are so many data centers being built out, so many of those data centers, you know, they're trying to furnish all of them with, you know, the equipment right now to get them up and running. People are paying whatever prices people are asking in order to get memory. And it's not even just memory, it's all of the other equipment that you need in order to get those data centers up and running. You know, if you're a project manager for a multi-billion dollar data center, you're not going to not open that data center on time because you can't get enough memory chips or CPUs, you know, coming in. I think that's probably one of the bigger changes that we saw this past quarter is, you know, things like CPUs that people really hadn't thought about that much, you know, in the past. Now we had a shortage in those CPUs, which are used in order to manage, you know, the AI workloads, in order to manage the amount of data going in and out of all of the GPUs, which actually do the AI calculations. So that's why we saw stocks like AMD and Intel, you know, do as well as they have, you know, this past quarter. As far as attribution analysis, I really don't really have to spend too much time on here. Again, really, I think probably the biggest takeaway on these slides is just noting how concentrated, again, the market really is in a handful of stocks leading the market up. You can see, you know, how those stocks have performed compared to, you know, where we rated them on a star rating basis and our price to fair values. You know, some of these stocks like Micron, you know, four star rated stock coming into the quarter up 242%, you know, just this past quarter. And it's not like we're standing still. I mean, we increased our fair value. I mean, we almost doubled it, but the market's certainly outpacing even the amount of value that we saw increasing, you know, for that company based on the shortages in memory stocks. And a similar story, you know, in a number of these other, you know, stocks as well. Detractors, you know, in the second quarter, I think more interesting part of this is I think it's really much more thematic than it was idiosyncratic. So for example, stocks like Exxon, Chevron, Conoco, all energy stocks that pulled back as oil prices subsided. Taking a look at, you know, some of the companies that are the ones that are expected to be disrupted by AI, some of these software stocks, Intuit, you know, Accenture, maybe not necessarily software stock, but you know, those services companies that people think will be disrupted by AI. And then communications generally, we saw a big pullback there as well. Once SpaceX filed their S1, a lot of people became very concerned that SpaceX, you know, may look to get into the traditional wireless market. We don't think that's going to happen. But again, that was enough of a concern to push stocks like AT&T and Verizon down, you know, quite a bit. Like really, one of the only ones that I think is very idiosyncratic would be Palantir. You know, this is a stock, it's been, you know, the poster child for, you know, those companies that can utilize AI in order to be able to generate, you know, new revenue. Stock had been skyrocketing for a while, it moved up too far into overvalued territory. I know is at least a two star may have hit, you know, one star territory as well. We've had a big pullback, you know, on that one. And in fact, at this point, not only has it pulled back, it's pulled back enough that last I saw, it was a four star rated stock. And then similar story, you can see, you know, which of these companies, you know, we thought were overvalued, you know, coming into the quarter, many of them falling enough that they're actually now getting into undervalued territory moving from, you know, maybe a three star to a four star, or in some cases, you know, maybe even a, no, there are no two going to four. So it's only three going to four stars. So this is a chart that I've been using for a while and actually been highlighting through most of, you know, the second half of 2023, you know, into 2025, highlighting on a relative value basis, how undervalued value stocks were compared to the broad market valuation, with as well as the value stocks have done on that relative value over the course of, you know, this year, we're now at the point where there's really no real benefit being overweight the value stocks as compared to that broad market valuation, and a similar story with small caps. So on that relative value basis, we've been highlighting how undervalued small caps were compared to the broad market valuation, good rally in small caps, it's now brought it much closer towards fair value with the broader market, still undervalued, we still think that has, you know, further yet to run at this point, but no longer as much of a margin of safety from the broad market valuation as we've seen in the past. You know, as far as, you know, second half risks, I mean, these are really substantially similar, you know, to what we were talking about in the first half of the year. Of course, AI stocks, they still require even greater growth to support the very high valuations that we see in AI, whether it's, you know, the leaders in technology, or it's with the commodity players, they all need to see ongoing growth in order to support those valuations. You know, I'll let Preston, you know, talk about oil prices and, you know, potential impacts on the economy and inflation over time. Of course, we have the impending, you know, midterm elections, you know, really hasn't been much discussion, hasn't really been in the headlines all that much, but I could certainly see a resumption in trade and tariff negotiations in the second half of the year. Private credit markets, weakening fundamentals generally is what we're seeing there, seeing a lot of markdowns in pricing, you know, within a lot of those private credit funds. Default rates are still elevated among the private credit markets. Chinese economies, you know, weaker than expected. I think the Chinese GDP number just came out. I think it was the lowest number they've had. And Preston, correct me if I'm wrong, but I mean, it's been probably years, if not, you know, decades that they've seen, you know, the kind of growth that they saw this past quarter. And real concern there is if that deceleration and growth, you know, continues to accelerate. And as we've talked about in the past, you know, the weakening, you know, Japanese yen continues to keep, you know, weakening versus the dollar. And so the carry trade is not as attractive as it's been in the past. So if we really had the Japanese yen really starting to lose value, I think that does have some systemic, you know, implications. Taking a look at sector valuations. So there's two ways, you know, that I look at it. First, this is just by a number or in this case, by percentage of four and five star rated stocks in each of the individual sectors. So you can see which sectors by number or percentage have, you know, the most overvalued or the most undervalued opportunities. This one is not market weighted. So this is really just by those number of stocks. Whereas when you start breaking it down by the market capitalization, then you can see here, you know, just how broadly undervalued like some of these different sectors are as a percentage of market cap overall. And then lastly, looking at it by individual sector price to fair value. So in this case, you know, looking at, you know, the technology sector being undervalued communications being significantly undervalued, you know, a couple of these, you know, probably more broadly, you know, kind of in line with the market. And a few of which, you know, like consumer defensive, we talked about overvalued as a sector. But again, that's just because Costco and Walmart are two star and one star rated stocks, we think those are significantly overvalued. Once you pull those out, a lot of the rest of the consumer defensive sector looks undervalued. And then the utility sector, you know, being overvalued as well. As far as, you know, the best picks coming from our sector directors, you know, just highlighting, there's a number of new best picks, which we've added to the list. Now, it's interesting too, though, if you look at like the basic material sector, which we say is, you know, 1% overvalued. So, you know, fair value to just slightly overvalued, harder and harder to find your undervalued ideas here. So two of those stocks are actually three star rated stocks, they are trading at a discount to price to fair value. But on a risk adjusted basis, that's not enough of a discount to get the four star territory. I'm not sure how you pronounce Lind or Lindy, a European company, but that's a new one, I think, to the list based on SpaceX, I believe they make a lot of the propellant that's used for the rockets. A couple of new names, you know, in the consumer cyclical sector, you know, Bank America being the lone US mega bank that we thought was undervalued coming into earnings this year. Then, you know, Charles Schwab, a new pick to the list, one that Susan and I actually just talked about on the morning filter the other day. And, you know, economically sensitive ones, you know, not as many, you know, new picks, you know, to this list, although I think it's interesting seeing that Nvidia is undervalued enough to come on to the best picks list, you know, trading at, you know, in this case, at the end of the quarter, almost a 30% discount to fair value. So, you know, one of those stocks with as much as it's run up, but then has no longer continued to keep moving higher, being, you know, in that four star category. And then lastly, a couple of new names here, you know, in the food and consumer package group sector, Campbell's, Kraft Heinz is one where it's been on the list, you know, kind of moved up and then kind of moved back down. So it's been on and off that list a couple of times. Clorox, I still think is one of like the widest mode names in the consumer product sector still trading at a discount. I think that stock is suffering from a lot of noise over the past couple of years, but not necessarily things that changed the signal. So I still think the fundamentals for the long-term outlook for that company looks pretty good. And then same thing, the utility sector, you know, we highlighted a couple slides earlier as trading at, I think like a 5% premium to fair value. So very hard to find undervalued stocks, and certainly even harder to find anything that's a four star rated stock. To get to like a four star rated stock in the utility sector, you have to start getting into more catalyst oriented story stocks, things that are going to require a much higher risk appetite. So in this case, we're just looking at a couple of three star rated stocks there. Probably one of the biggest differentials that we've seen since the beginning of the year is going to be in how we look at valuations by economic moat. Of course, wide economic moat companies against a very Graham and Dodd-esque, very Warren Buffett type of analysis. Does this company have long term durable competitive advantages that will allow the company to generate excess returns? You know, over the long term, in this case, to be a wide moat has to be for 20 years or more. Narrow moat companies have to generate those excess returns for 10 years or more. And then no moat companies, we always assume that, you know, over the course of our forecast period, that even if they're generating excess returns today, those returns again, you know, competed away very quickly. So what we've seen with a lot of these, you know, tech commodity oriented companies, those are no moat rated companies. And because they've moved up so far so fast, that's really started to skew that no moat category way too far into overvalued territory, specifically within the no moat growth category. So those are the ones that we would certainly look to, you know, steer clear of, or at least underweight in your portfolios the most for the second half of the year. And then using, you know, Morningstar screening tools. So depending on which platform you use, in this case, you know, every quarter, I just go through, I do a screen of large cap stocks with wide economic moats. You know, specifically, I try and find those with medium and low uncertainties. Although I have included this time around a couple that have high uncertainty as well, just because I wanted to highlight, you know, some of these other stocks trading at large discounts. Similar story going through that same screen, you know, with mid cap stocks. And then lastly, going through the screen for small cap stocks. So these are, of course, you know, in the slide deck, they're in the report. So feel free to download those. And I use Morningstar in order to do your own analysis and review of those. So with that, I'm going to take a break, have a drink of water here and pass it off to Preston for his U.S. economic outlook. [00:27:25] Speaker 3: Thank you, Dave. Good afternoon, everyone. So at a high level, I would characterize the current U.S. economic landscape as this. GDP growth is slowing incrementally. That's increasing the slack in the economy, notably the labor market. And so if we don't have persistent supply side shocks, inflation should ultimately converge back to the Fed's 2% target, which will enable further interest rate cuts eventually. So when I say GDP growth is slowing, we saw growth slow to 2.1% in 2025, about 70 basis points slower than in the prior three years over 2022 to 24. And that's been due to a number of factors, lower population growth, but especially the lingering effects of high interest rates, which means that the Fed's somewhat restrictive monetary policy stance is having its intended effect. And indeed, in the absence of supply shocks, first tariffs last year and continuing this year, and then the Iran war this year, we would have seen inflation fall in 2025 and this year, although probably not all the way back to 2%. As it stands, inflation was flat in 2025 at 2.6%, with a tariff shock contributing about 20 basis points of upward impact. And this year, inflation is rising to 3.4%, driven by a 65 basis point contribution from the oil price shock. But we do think inflation should eventually return to falling as long as GDP growth remains slightly subdued and that maintains a level of slack in the labor market. Then that and other forces should act to push inflation back down to the Fed's 2% target. And that opens the door to further interest rate cuts, as I mentioned, what should allow GDP growth to reaccelerate in the later years of our forecast. Digging a little bit more deeply into the GDP data. Some factors to consider. So last year, we did have a 30 basis point headwind from net exports and inventories, which is kind of a volatile component. And we know net exports was negative because there was a jump in imports at the beginning of the year, especially to try to beat the tariffs. So that subtracted from GDP growth last year. It's probably going to add a little bit this year. And so GDP growth is bouncing up this year. But I would say still the overall trend is downward, which is what we expect to continue in 2027 and 28. One theme is just that there were some kind of, you know, one off factors that had been boosting growth that are fading away. So you see that government spending is contracting and that's not just at the federal level. But spending growth is contracted at the state and local level as some of the post pandemic surpluses have finally been spent down. And so spending growth is running lower there. Of course, you know, a major factor that's boosting the economy right now that as I'll talk about is AI, and that's causing business investment to expand in its growth rate this year. That's offsetting a consumption slowdown, as you can see, that's happening this year. As it stands, the personal savings rate is very low at 3.1% on average in the last three months, you know, nearly four percentage points below its 2019 average of 6.9%. And so that speaks to this, you know, this sentiment that we see that consumers feel somewhat squeezed. Although I would say some of this has to do also with very high equity prices, which is allowing or is inducing higher income households to spend more out of their current income than they would have otherwise. But still, though, I do think that there's an impetus for households to start to slow their consumption growth in order to boost those lagging savings rates. And that should keep consumption growth restrained over the next few years. And then eventually, we do expect AI driven investment to slow in growth, not not to drop off and fall outright and level, but at least to grow at a more moderate pace compared to what it has in the last few years. And that will constrain business fixed investment and slow on the overall way on the overall rate of GDP growth. And then, as I mentioned, monetary policy loosening should drive a reacceleration in growth in the later years of our forecast. And, you know, it's really remarkable to see the extent to which AI is propping up the economy when we just look at private fixed investment, where tech related categories driven mainly by AI are accounting for more than all the growth in in private fixed investment. So these tech related categories were up around 14.9% year over year in the first quarter of this year, whereas all other non-residential or business fixed investment was down 4%. Residential is down 5.5%. So the whole economy in terms of investment spending is actually contracting at a substantial pace, excluding these high tech categories boosted by AI. And I would say this reflects to a great degree, the continuing effect of high interest rates. Of course, we know residential investment is very interest rate sensitive. So looking at inflation, I would say the market has, you know, perhaps even more so than the rise in energy prices been concerned with this uptick in core inflation, you know, likely to post it around 3.3% year over year in terms of the PCE price index, core price index as of June, compared to an average 2.8% in 2025. But, you know, we're a little less concerned about this rise. I think, you know, one factor that's getting into the weeds, but it's interesting is that software is contributing about 20 basis points to the rise in core inflation this year. We know actually that's going to be revised away almost certainly when the BEA does its annual update at the end of September, because the data that the source data that they were using to measure price changes for that software component of PCE has some significant flaws. And so the BEA is changing that that will directly remove about 20 basis points from that core PCE measure. Tariff shocks have also been affecting core goods prices. I think there's still a little bit more of that yet to be passed through. But, you know, by the end of this year, we should be getting to the end of that that tariff pass through. And then, you know, ultimately, I'm very comfortable with core services inflation falling because of what's going on with wage growth. So our composite measure of wage growth stood at three point five percent year over year in the first quarter. And that's based on the preliminary data that's continued in the second quarter. Now, you know, assuming that labor costs grow in line with the overall size of GDP, that is, the labor share remains stable, then we can subtract the productivity growth rate in the economy from the wage growth rate. And that gives you the implied inflation rate. And that's an accounting relationship that has to hold with certitude. So productivity has been running at one and a half to two percent and should continue to. So subtracting that from three and a half percent wage growth and we get an implied inflation rate at one and a half to two percent. So the labor market and wage growth is in no way contributing to the continued inflationary pressures that we see. And if it persists where it is right now, which I think it should based on our forecast for the labor market, that will provide a major downward impulse for inflation, especially core services in coming years. So in terms of, you know, how market expectations have evolved recently, I think it's been interesting that, you know, early in this year, we had a major correlation between bond yields and oil prices, which is to say that when oil prices shot up as the conflict erupted over Iran, bond yields moved up along with it as inflation expectations expanded, as you can see in the break even component of the five-year treasury yield. But yet now that oil prices have come back down, we've seen bond yields remain resilient and even increase a bit further. So what's driven that, of course, is not the inflation component of yields, but the real or inflation adjusted component of yields. So real five-year treasury yields at its tips have increased by some 80 basis points since March. So what does that mean? Well, the market is essentially assessing the strength of the economy and its ability to withstand high interest rates as being as having expanded compared to what it expected, you know, three to six months ago. And that's been driven to a great degree, I think, by the labor market data. But I do think there's been a bit of an overreaction here. You know, this data is inherently volatile. And it's true that, you know, in the last three months, we've seen non-farm payroll growth expand to about an 8% annualized pace, which would be very likely in excess of break-even job growth. That is the unemployment, the rate of job growth at which unemployment is unchanging. But year-over-year growth is still stuck at about 0.3%. I think that's a better measure of the underlying trend. Even if we, you know, just look at private employment, that's at 0.5% growth year-over-year. So I'd still say that the labor market is in a weak state. It's no longer weakening as it was in the second half of 2025. But I wouldn't say that it's strengthening either. And I would say that there's still a measurable amount of slack in the labor market, which is weighed on wage growth. So now I want to talk, tackle this topic of what is AI doing right now? You know, is it a supply shock? Is it a demand shock? Is it boosting inflation? Will it eventually reduce inflation? And so I would say that AI right now is mostly an aggregate demand shock, and it's a big one. So we would estimate that AI, properly measured, would be contributing around 60 basis points to GDP growth in 2025. Now, in actuality, because of some measurement issues, it's probably about 40 basis points, because it looks like the BEA has under-measured investment on the tech side. And of course, there's, regardless, that's a substantial contribution, and there's some multiplier associated with that because it is investment spending. And separately, AI is clearly boosting consumption via the wealth effect of high equity prices. So it's having a huge impact on the demand side economy. I would say, you know, it's, you know, the predominant driver of the demand side of the economy right now by a long shot. But what does that mean for AI to be a demand side shock? Well, this is what this diagram here is illustrating. So this looks at the relationship between the real interest rate and GDP. Now, the vertical line here corresponding to potential GDP is simply this, is saying that if the Fed is doing its job perfectly, then GDP should line up with its potential. That's the full employment part of the Fed's dual mandate. And coincidentally, you know, assuming that you don't have supply shocks going on, which isn't the case right now, but in general would hold, then inflation also lines up with its target. So that's kind of the Goldilocks zone right there for the Fed, for GDP to line up with potential. And if that's the case, then any demand shock that we see, whether it's from AI or anything else, should be offset by a monetary policy adjustment, which means that the the main effect of a demand shock is on interest rates, not on GDP growth, actually. And so I would say that the main impact of this AI investment boom is actually pushing up interest rates higher than they would have been otherwise. That is to say, if we had not have gotten this AI boom the last few years, the economy would have weakened and the Fed would have responded by cutting interest rates much closer to where they were before the pandemic. So to the extent that the neutral rate of interest has risen compared to pre pandemic levels, that's driven by AI, because most of the other forces driving neutral or the kind of the long run rate of interest are still pushing in that downward direction. So when when could AI and so just to sum this up, you know, assuming that the Fed's doing its job, AI is is more of an interest rate shock, not a GDP or an inflation shock, right? Because if it's not impacting GDP, then also, you know, via a kind of a normal Phillips curve correlation between GDP growth and inflation, it can't be impacting inflation either. Now, to some extent, I would say, you know, in the short run, because the Fed's adjustment capacity is limited, it is having some upward impact on GDP and inflation. But I would say the main impact really is on the interest rate side. Now, when when could it switch to becoming more of a supply side impact? It is true that productivity growth has accelerated, but that began so we've averaged 1.9% productivity growth since 2020, well above what we saw in the prior decade. But I would say that began well in advance of mass uptake of LLMs and other AI technologies. And so I don't think it's primarily attributable to AI. So I think it's still going to take a few more years before AI transitions from being a demand shock to also being a supply shock. So I want to pivot now to oil prices, just to speak a little bit more on this. So oil prices have rebounded over the last couple of weeks, obviously, as tensions have reignited. And I think now we're at a place where I'm more comfortable with where futures prices are. I think markets were a bit complacent two weeks ago when WTI was south of $70 per barrel. We incorporate the futures curve over the next three years into as our methodology driving our energy price forecast. We do have a longer term view on oil, but given the abundance of information factored in the futures prices, that's the basis of our short term forecasts. But there have been certainly some times when I think that futures markets have been a little bit off the mark. But right now, I do think things are appropriate, mainly because I think both sides are looking significantly risk averse. In particular, I think that the president is quite averse now to high oil prices as midterms approach. And so I do think that the restart of tensions that we've seen in the past week or so mainly reflects, you know, posturing for bargaining rather than any desire to prolong this war and the closure of the Strait of Hormuz for another, you know, multi-week or multi-month period. I don't think that's an appropriate base case right now. Regardless, you know, the market has consistently expected this to be a finite duration conflict, as reflected in the 12-month futures prices, never having broken north of 80. And I do think that's consistent. I think that's appropriate. We haven't seen anything to suggest that this war would knock out supply for, you know, a period of longer than one year. So based on our views on inflation and GDP growth slowing, we do expect the Fed to, while having to hike interest rates one time this year in September, we think they will return to cutting next year and in 2028, ultimately delivering a net 100 basis points in interest rate cuts. So taking the target range of the federal funds rate from three and a half to three and three quarters, down to two and a half to three and three, two and a half to two and three quarters by the end of 2028. And that should be sufficient to drive also the longer end of the curve lower with the 10-year treasury yield dropping to three and a half percent down from around 4.6% right now, which should also push down mortgage rates and other key borrowing rates, which I do think will be needed to sustain a continued healthy rate of economic growth. In particular in the housing market, I think this renewed weakness that we've seen in housing with residential investment contracting does reflect the a very large lingering effect of high interest rates as home buyers have become increasingly impatient with with mortgage rates remaining high, you know, no longer or to a lesser degree buying this story that they can just refinance down the line when that hope looks increasingly distant and eventually the Fed will have to deliver on that hope by pushing down mortgage rates. So with that, I'm going to turn it back over to Dave. Thank you. [00:46:50] Dave Sequeira: All right. Thanks, Preston. Of course, I'm old enough to remember my first mortgage, I think was eight and an eighth. So again, rates still look attractive to us old guys. All right. I'm going to just kind of run through a couple of quick slides here. I do want to have enough time to answer some more questions. So again, just a heat map of the star ratings across the U.S. market index showing by capitalization, showing which of those mega cap stocks we think are undervalued today. Market concentration, we've addressed that in the past. Just taking a look at undervalued mega cap performance for the second quarter. These were the ones at the end of last quarter we identified, you know, as being undervalued, you know, what the performance has been, you know, over the course of the quarter and then what we've done with our fair values, you know, over that same time period. And again, the overvalued ones and then the updated list of mega caps where we are, you know, today in the updated list of overvalued. So again, these are in the slide deck. So please go ahead, download the slide deck or the report and you can go through these at your leisure. Fixed income outlook. So Morningstar U.S. core bond index, that is our broadest measure of the fixed income market, you know, only up, you know, 66 basis points, you know, in the second quarter. So really not that strong of a performance. I think a lot of it's just been because, you know, we have had rates rise across the curve, really in the kind of that six month to five year, you know, belly of the curve, which is where we saw rates increase the most, just as the market, you know, started pricing in higher and higher probabilities of the Fed increasing rates this year. You know, as far as your corporate bonds go, you know, we had a brief blip, you know, when they just started to maybe start looking attractive again at the end of March. And as soon as the equity market rallied, you know, the corporate bond market, both investment grade and high yield rallied right back again. So we are back to the point where these corporate credit spreads for both are still, if we go back all the way to the year 2000, I mean, these are near like their lowest levels that we've seen, you know, in the past, you know, 26 years. So again, I just don't think you're really getting paid to take on that extra risk for downgrades and defaults. So in the fixed income market, I still prefer sticking with, you know, whether it's sovereign treasury bonds, US bonds, maybe even like some CMBS and some ABS. But as far as corporates go, I just don't see the attraction here. And then just to note in the private credit market, you know, we are still seeing, you know, an increase in, you know, like more downgrades and upgrades in that private middle market area. Among those private credit funds, you know, they're still seeing redemption requests in excess of what they're allowed to redeem every quarter. So I think there's still a lot of people trying to get out of, you know, a lot of those different funds. We are seeing a lot of price marks finally starting to come down. We're seeing some big price mark, you know, decreases where things might go from par all the way down to 80 cents on the dollar, you know, in one fell swoop. My guess is there's probably still more of that, you know, yet to come. So I still think that the private credit market has got, you know, further to fall before it gets to the point where I think it's going to be adequately priced based on the amount of credit risk there. [00:50:05] Susan Jabinski: All right. Well, we will wrap right there. I'd like to thank Dave and Preston for their time today. And of course, thank everyone for joining Morningstar's third quarter 2026 US stock market outlook webinar. We hope to see you next quarter. Take care. 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.