The bear growled this past week as the S&P 500 Index skirted the (-20%) threshold. But then came Friday, and markets bounced back, much to investors’ relief. The Index is still technically in a correction, although that may change next week if more bad news arrives.

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However, according to Stock Rover*, the Nasdaq and the Nasdaq 100 are clearly in a bear market. I have pointed out recently that some tech stocks are down much more. In general, stocks are now undervalued, and some deals are to be had. However, investors should still expect more volatility.

Source: Stock Rover*

Why Markets Recovered on Friday?

Over the past several weeks, we have covered the reasons why the stock market is struggling. The reasons include inflation, high oil and gas prices, the resurgence of COVID-19 in China causing excessive lockdowns, and the conflict in Ukraine.

However, three days ago, a positive number about inflation was reported, indicating slowing. The US Bureau of Labor Statistics said that the CPI grew by only 0.3% in April 2022, or 8.3% in the past 12 months. The 0.3% was the lowest since August 2021, and the 8.3% value showed a decline from March 2022. Notably, prices for energy, used cars, and apparel declined.

Before this, the stock market was arguably continuing its downward trend on the expectation of worsening inflation. In addition, there was positive news that China would ease its lockdowns allowing factories to reopen and global supply chains to function normally again. Lastly, the conflict in Ukraine is not abating, but at the same time, it seems to be heading to a protracted phase and not expanding like some feared and may not impact inflation as much as expected.

However, the bottom line is if inflation is peaking and trends down, the US Federal Reserve will not need to be as hawkish and aggressive with their interest rate increases.

Stocks Are Undervalued

Stocks are now undervalued. Last week, Morningstar highlighted that many stocks were trading below their fair value estimate. Dividend growth and income stocks like Starbucks (SBUX), T. Rowe Price (TROW), BlackRock (BLK), Microsoft (MSFT), Intel (INTC), Gilead Science (GILD), Emerson Electric (EMR), Medtronic (MDT), and Merck (MRK) are all undervalued according to them. Note that I own several of these stocks and added to existing positions this past week.

Despite the bounce back in the stock market, many stocks are still down substantially YTD. A helpful map from finviz plots companies by market capitalization, sectors, industries, and year-to-date (YTD) performance. More defensive sectors and industries like telecom, drug manufacturing, consumer defensive, and utilities are performing relatively well. Aerospace is performing well due to the conflict in Ukraine. Energy is up because of high oil and natural gas prices.

If investors examine the forward price-to-earnings (P/E) ratio, the picture becomes more evident. Many companies are trading at low valuation multiples. In addition, dividend growth stock categories are trading at their lowest valuation from March 2020 to May 2020. However, bear in mind that not all stocks are undervalued, but there are many to choose from now.

Quoting Warren Buffett,

Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.

Uncertainty actually is the friend of the buyer of long-term values.

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful.

Although not all investors have capitulated, many are now on the sidelines, and it is probably time to be contrarian, at least in my opinion.

Source: finviz

Final Thoughts on Stocks Are Undervalued

Recent market volatility and poor earnings from some high-flying growth stocks have punished the markets. However, many of those stocks benefitted from strong pandemic tailwinds but now face headwinds. Second, other growth stocks were unprofitable and bid up to excessive valuations. Third, some high-quality stocks with long-term dividend growth have declined in the market downturn. For instance, Lowe’s (LOW) is down from its 52-week high of about $263 per share and is now at ~$194 per share, trading at a multiple of ~14.5X. Lowe’s is a Dividend King too. Investors should focus on these high quality stocks in their research.