On the hunt for cheap stocks due for a second half bounce with Morningstar

Healthcare stocks are emerging as an attractive defensive play for investors anticipating a volatile second half, currently trading at an appealing 17 times forward earnings compared to the S&P 500's 23 times. This sector, which appears even more undervalued when excluding high-flyer Eli Lilly, offers a crucial 'margin of safety' due to its relatively cheap valuations and above-average dividend yields. Morningstar's Dave Sekera emphasizes this opportunity as the broader market approaches fair value amidst increasing risks.

Analysis

The healthcare sector is emerging as a compelling defensive play for investors anticipating volatility in the second half of the year, primarily due to a significant valuation discount. The S&P 500 health care sector trades at 17 times forward earnings, well below the broader S&P 500's 23 times multiple. This undervaluation is particularly stark when excluding high-flyer Eli Lilly (LLY), which trades at a lofty 36 times forward earnings on the success of its GLP-1 drugs. According to Morningstar, removing LLY from the calculation reveals a sector that is even more attractively priced, offering a distinct opportunity. This relative cheapness, combined with the sector's above-average dividend yields, provides a "margin of safety" as the broader market approaches fair value amid risks from tariffs and deficits. Recent market activity, where healthcare giants like UnitedHealth, Johnson & Johnson, Amgen, and Merck rallied while tech stocks retreated, suggests a capital rotation into the sector may already be in progress.

Key Decisions for Investors

• Investors should consider increasing allocation to the healthcare sector to capitalize on its defensive characteristics and significant valuation discount relative to the broader market.
• It may be prudent to re-evaluate exposure to Eli Lilly (LLY), as the stock is flagged as potentially overvalued at 36 times forward earnings, and instead focus on the more attractively priced large-cap names within the sector.
• Focus on established, dividend-paying healthcare companies such as UnitedHealth Group, Johnson & Johnson, and Merck, which are highlighted as offering a 'margin of safety' and appear to be beneficiaries of an early investor rotation.
• Monitor sector fund flows and relative strength indicators to gauge the durability of the nascent rotation from growth-oriented technology stocks into value-oriented healthcare.