As markets rebound from their April lows, attention has returned to concerns over US equity valuations, particularly with the continued outperformance of the technology sector and the so-called ‘Magnificent 7’, buoyed by strong quarterly earnings.
At Morningstar Wealth, however, we believe there are opportunities beyond the headline indices. Two areas, in particular, warrant closer inspection.
Weighing the long-term potential of healthcare
One area of interest is US healthcare, one of the few sectors still in negative territory year to date. The Morningstar US Healthcare Index returned -3.03% to the end of May. What’s driving this underperformance?
A key factor has been the sharp decline in UnitedHealth shares, down around 40% this year. As one of the index’s largest constituents, UnitedHealth has faced rising medical costs and higher-than-expected patient claims, pressuring margins and leading to a Q1 earnings miss. Yet, despite near-term headwinds, UnitedHealth remains well-positioned to benefit from long-term trends in US healthcare spending.
In a market swayed by politics and macro headlines, the key is to maintain a valuation-driven investment approach
Regulatory pressure has also weighed on sentiment. The Trump administration has proposed measures requiring biopharma companies to negotiate drug prices with the Department of Health and Human Services or face compulsory pricing mandates. Specifically, a “Most Favoured Nation” policy would require US drugmakers to match lower prices offered internationally.
Morningstar Equity Research estimates that US drug prices are, on average, roughly double those in major developed markets. While aligning prices could reduce revenues, implementation details remain uncertain. Healthcare reform is not the administration’s top priority, and any sweeping changes would require Congressional approval — challenging given the Republican Party’s slim majority.
With the probability of extreme outcomes relatively low, valuations have become compelling. The US healthcare sector, which traded at a premium a year ago, now sits at an 11.6% discount to Morningstar’s fair value estimate. For investors willing to look beyond short-term political noise, the sector offers attractive entry points, underpinned by innovation and long-term growth drivers.
Cyclical pressure, structural opportunity
Economic uncertainty has also hit US small caps hard. These companies tend to be more cyclical and underweight in technology, with higher exposure to industrials, real estate and financials contributing to their recent underperformance.
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Despite this, we see upside potential. The median small-cap stock now trades at a 10% discount to fair value. In addition, small caps offer meaningful diversification: they generate 79% of revenue domestically, compared to 60% for larger US firms. If trade tensions escalate, this domestic focus could provide insulation from foreign revenue risk.
Staying focused amid the noise
In a market swayed by politics and macro headlines, we believe the key is to maintain a valuation-driven investment approach. That’s why we continue to allocate to US healthcare and small caps, increasing exposure in our latest portfolio rebalance.
While these opportunities may take time to deliver returns, we believe the combination of compelling valuations and long-term growth potential makes them worth the wait — balanced, of course, with more defensive equity and fixed-income holdings.
Raymond Sham is an investment analyst at Morningstar Wealth
