AY - Peter Lynch Says This Is Where The Bargains Are Right Now

2023-10-31 12:00:55 ET

Summary

• Leading market valuation metrics indicate that the stock market is overvalued right now.
• Peter Lynch, however, believes that there are abundant bargains in the current stock market.
• We share where he thinks the bargains are to be found and what our top picks are.

While the S&P 500 (SPY) looks overvalued based on many leading valuation models, Peter Lynch believes that a certain sector of the stock market is extremely undervalued right now. In this article, we will look at why the broader market indexes are overvalued, what exactly Peter Lynch is referring to, and then share some of our top picks right now.

Why The Stock Market Is Overvalued Right Now

There are several leading market valuation metrics that indicate it is overvalued right now:

1. The Buffett Indicator , which compares the total market capitalization of the stock market to the U.S. GDP, suggests that when the ratio exceeds 100%, the market may be overvalued.
2. The S&P 500's Price-to-Earnings (P/E) Ratio indicates that the market might be expensive relative to its earnings power.
3. The Mean Reversion Model , which is based on the idea that stock prices tend to revert to their historical average over time, further supports the case that the stock market is overvalued right now.

In addition to these valuation models, there are several external factors that further diminish the outlook for the stock market moving forward:

• Geopolitical tensions are high, with Israel's conflict with Hamas and Russia's ongoing war with Ukraine creating uncertainty in global markets. The looming threat of conflict in East Asia further exacerbates these concerns.
• Elevated interest rates are weighing on borrowing and investment activity, potentially slowing down economic growth.
• Persistent inflation is eroding purchasing power, affecting consumer spending and corporate profitability.
• Finally, the increasing threat of a recession is weighing somewhat on consumer and corporate confidence and spending, further dampening stock market prospects.

As a result, it is hard to get too excited about taking on equity risk at the moment.

Peter Lynch's Favorite Type Of Stock Right Now

That said, while major market indexes like the S&P 500 (VOO)(SPX) and the Nasdaq (QQQ) may very well be overvalued right now, legendary investor Peter Lynch believes there are abundant bargains in the current stock market. He recently pointed out that the market as a whole has been in an incredible bear market for quite some time now if you exclude around 10 mega-cap stocks like Apple (AAPL), Tesla (TSLA), NVIDIA (NVDA), Microsoft (MSFT), Amazon (AMZN), Meta (META), and several others that have largely been driving the performance of major market indexes over that period.

As a result of this sharp market bifurcation between mega-cap tech valuations and much of the rest of the market, Mr. Lynch emphasized that many stocks now trade at rock-bottom valuations, providing investors with abundant opportunities to buy stocks at very attractive prices. He particularly emphasized that he thought that the Russell 2000 (IWM), a small-cap index, was on sale, implying that stocks with a smaller capitalization provide a particularly attractive opportunity for investors right now.

Our Top Picks

Given Mr. Lynch's appetite for small-cap stocks right now, we are also feasting on opportunities in the small to medium-cap sector. Our favorite places to look for value right now are in infrastructure (XLU), midstream energy (AMLP), and REITs (VNQ), with numerous names looking particularly appealing in each space. One of our favorite infrastructure picks of the moment is Atlantica Sustainable Infrastructure (AY) given its low level of corporate debt, self-amortizing debt at the asset level, relatively few upcoming debt maturities, and very stable, long-term contracted cash flows from almost entirely investment grade tenants via PPAs. It also has considerable CPI indexing in its PPAs, further insulating it against a scenario in which inflation and interest rates are potentially higher for longer. Meanwhile, investors collect a very attractive and sufficiently covered tax-advantaged ~10% distribution yield while they wait for the stock price to recover.

In midstream, we like Energy Transfer (ET) a lot given its discounted valuation relative to its investment grade peers, near 10% distribution yield that is well covered by distributable cash flow, solid BBB rated balance sheet, and stable cash flows that are ~90% contracted.

In the REIT sector, one of our top picks of the moment is Crown Castle (CCI) due to its deep discount to NAV, investment grade balance sheet, attractive long-term growth potential, and substantial 7% dividend yield.

Investor Takea.lway

While major market indexes look dangerously overvalued and numerous macroeconomic and geopolitical headwinds appear likely to send the market lower, it is important to keep a few facts in mind:

• Other than the leading mega-cap tech stocks, much of the stock market is trading at compelling valuations.
• Some of the most beaten down sectors (such as infrastructure/utilities and REITs) are also among the most defensive.

As a result, if these macro headwinds end up indeed sinking the economy, interest rates will likely fall along with economic growth, providing a tailwind to these beaten-down sectors (that are generally quite interest rates sensitive) which should also generally outperform in an economic downturn.

We therefore are joining Mr. Lynch in stating:

I love it when stocks go down.

and are buying stocks like ET, CCI, AY, and many more hand-over-fist while they trade at rock-bottom valuations.

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