Markets Brief: Volatility Shines a Light on Small-Cap Stocks

Fed Disappoints the Market

US stocks fell sharply despite the Federal Reserve cutting interest rates by the expected 0.25 percentage points and lower-than-expected inflation. Like a rerun of A Christmas Carol, the joy of Christmas present was replaced by fear over a Christmas yet-to-come as the interest-rate forecasts of individual members of the Federal Open Market Committee (the “dot plots”) indicated fewer rate cuts than expected in 2025 and less support for the economy. You can read more about the implication of the dot plots in this article by senior US economist Preston Caldwell and get more details on the inflation data from Bella Albrecht here.

Corporate Bonds Track Equities

Fixed-income prices also fell over the week. Corporate bonds fell further than Treasuries as credit spreads rose. While the impact on spreads was more muted than during the brief panics of July and September, it is a good reminder that corporate bonds tend to exhibit higher correlation to equities than Treasuries and so should be treated differently when used in portfolios. The value of the US dollar also rose sharply before falling back on Friday to end the week 1% higher.

Volatile Markets Make Mistakes Likely

The sharp fall in stocks on Thursday and partial recovery on Friday was likely exacerbated by fewer market participants being engaged due to the holidays. At these times, it is natural for investors to feel inclined to sell their investments, while others will try to profit from the volatility by making purchases and sales in the hope of short-term gains. When these feelings arise, the apparent indolence of professional investors can seem puzzling or even frustrating. However, the most profitable response to such situations is to maintain a long-term perspective and avoid the flight or fight instinct that grips us.

For most investors, the continued growth in the profitability of well-managed companies, supported by the dynamism of the US economy, will provide almost all the gains over our investing lifetime. We can seek to enhance these returns by favoring undervalued assets over those that are expensive, but this can’t replace the core engine of our portfolios. Consequently, periods of volatility increase the likelihood that we will make mistakes and are periods when we are normally better served by sitting on our hands than making big changes.

Large-Cap Gap

Although the US market became less overvalued as a result of the price movements last week, valuation gaps within the market widened as small companies fared worse than large companies. The gap between large growth companies and small value companies has widened further, with the latter trading at a 13.4% premium to Morningstar’s estimate of fair value while the former is trading at an 11.1% discount. For those investors wishing to exploit this gap in expected returns, Tori Brovet has written about Morningstar’s favored small-cap funds here.

Energy Stocks Under Pressure

At a sector level, technology stocks fared the best while energy and basic materials fared the worst. Energy companies have been dogged by weak demand and fears of excess supply when the current OPEC production cuts are unwound. While the latter appears unlikely in 2025, forecasters such as the International Energy Agency continue to expect supply growth to outstrip demand in 2025. This negativity is weighing on stock prices in the sector, with US energy companies currently priced at a 13.4% discount to fair value. To help investors access this opportunity, Josh Aguilar, Morningstar’s sector director for US energy, highlights the most attractive opportunities in this article.

Expect Market Volatility

Economic data is sparse over the next couple of weeks. While that should reduce the probability of surprises feeding through into asset prices, fewer active market participants will increase the likelihood of further volatility. For those who do want to keep track of the economic and company announcements, find them in this calendar.

Highlights of This Week’s Market and Investing Events

Monday, Dec. 23: Consumer Confidence Survey

Tuesday, Dec. 24: Durable Orders, New-Home Sales

Thursday, Dec. 26: Initial Unemployment Insurance Claims report

For the Trading Week Ended Dec. 20

• The Morningstar US Market Index fell 2.2%.
• The best-performing sectors were technology, up 1.1%, and utilities, up 1.4%.
• The worst-performing sector was energy, down 5.6%.
• Yields on 10-year US Treasury notes rose to 4.52% from 4.40%.
• West Texas Intermediate crude prices rose 0.1% to $69.49 per barrel.
• Of the 874 US-listed companies covered by Morningstar, 119, or 14%, were up, one was unchanged, and 754, or 86%, were down.

Which Stocks Are Up?

Teva Pharmaceutical Industries TEVA, Nissan Motor NSANY, Shoals Technologies Group SHLS, Darden Restaurants DRI, and SolarEdge Technologies SEDG were the top performers among US-listed stocks covered by Morningstar analysts.

• Teva topped the list, rising 33.9%. Up 20.0% over the past three months, this no-moat company with a 3-star rating has increased 100.5% over the past year. The stock closed the week at $22.10, trading at an 8.0% discount from its fair value estimate of $24 per share.
• Nissan was the second-best performer, with a weekly return of 21.9%. The 4-star stock has gained 0.5% over the last three months. Shares in this no-moat company are down 24.9% over the past 12 months. Nissan stock wrapped up the week at $5.70, trading at a 38.3% discount to its fair value estimate of $9.20 per share.
• Ranked third for the week, Shoals saw its stock rise 16.1%. The 3-star, no-moat stock has declined 27.6% over the last three months and lost 71.6% over the past year. At the end of the week, Shoals stock was trading at $5.10, a 2.4% premium to its fair value estimate of $5 per share.
• Darden stock climbed 12.5% in the latest week. This narrow-moat company has seen an increase of 7.3% over the last three months and a rise of 14.1% over the past year. The 1-star stock ended the week at $187.60 per share, a 29.4% premium to its fair value estimate of $145.
• The fifth-best-performing stock was no-moat SolarEdge, which gained 10.6%. The 4-star stock has dipped 38.2% over the last three months and is down 87.2% over the past year. SolarEdge finished the week at $14.80, trading at a 17.9% discount to its fair value estimate of $18 per share.

Which Stocks Are Down?

EVgo EVGO, Lamb Weston Holdings LW, Novo Nordisk NVO, Compass Minerals CMP, and Celsius Holdings CELH performed worst among US-listed stocks covered by Morningstar analysts.

• EVgo was the week’s worst-performing stock, falling 28.4%. This 2-star, no-moat company has increased 1.2% over the last three months and 17.9% over the past 12 months. The stock concluded the week at $4.40, trading at a 24.6% premium to its fair value estimate of $3.50 per share.
• Lamb Weston came in second, with a 21.7% decrease in its price this week. The narrow-moat company, rated 4 stars, has fallen 4.2% in the past three months, though it’s increased by 39.6% over the last year. Closing at $62.10, the stock trades at a 24.3% discount to its fair value estimate of $82 per share.
• Novo Nordisk took third place, with a 20.5% drop this week. This 2-star, wide-moat company is up 23.3% over the last three months and 4.9% over the past year. The stock finished the week at $85, trading at a 1.2% discount to its fair value estimate of $86 per share.
• Compass Minerals’ stock price fell 18.4% this week. The narrow-moat, 4-star company has increased 1.8% over the past three months and 56.5% over the last year. At $10.70, the stock trades at a 46.7% discount to its fair value estimate of $20 per share.
• Celsius rounds out the list with a 15% decline this week. This 3-star, no-moat company has increased 18.0% over the last three months and 45.2% over the past 12. The stock closed the week at $27, trading at a 16.9% discount to its fair value estimate of $32.50 per share.