Navigating the May 2025 Stock Market: Strategic Insights Amidst Market Volatility

How Investors Can Position Themselves to Weather the Storm in the US Stock Market

Key Takeaways

The US stock market is currently trading at an 8% discount, presenting a potential buying opportunity.
Investors should consider a market-weight stance but with an emphasis on value and core stocks.
Valuations are rising toward fair value, particularly in sectors like energy, which is increasingly attractive.

May 2025 US Stock Market Outlook and Valuation

As of April 30, 2025, the US stock market is trading at an 8% discount to its fair value.

This level has remained consistent since the end of March.

However, this calculation fails to account for the market’s significant dip in early April, which was triggered by the US tariff announcement, followed by a strong rebound.

On April 4, 2025, the price/fair value ratio reached a 17% discount, at which point we recommended overweighting positions, as this discount presented a solid margin of safety for long-term investors.

Following the announcement of a 90-day tariff pause, the market rebounded sharply, and valuations have nearly returned to their pre-tariff announcement levels.

Given this rapid recovery, now seems like an opportune time to lock in profits from the overweight position and revert to a more neutral market-weight stance.

Morningstar US Equity Research Coverage Price/Fair Value Estimate

Eye of the Hurricane: The Calm Before the Storm

The first signs of the looming market storm appeared in March 2025, as the artificial intelligence (AI) sector entered a bear market, dragging down the broader market.

Yet, this initial dip turned out to be minor, with the true volatility beginning when President Donald Trump announced new tariffs on imports from China.

The stock market quickly plunged, marking a formal bear market as the Morningstar US Market Index dropped 20% from its highs.

However, just as quickly as the storm hit, the clouds began to part. In an attempt to ease tensions, President Trump announced a 90-day suspension of the tariffs to allow for trade negotiations.

This announcement spurred a market rally, and stocks regained their losses, returning the market valuation to where it was at the end of March.

As we head into May, the market seems to be in a temporary calm, but the risk of renewed volatility remains high.

Trade negotiations are ongoing, but final agreements are unlikely before the 90-day pause expires on July 8.

We anticipate that new agreements might only be reached as the deadline approaches.

Economic and Earnings Distortions in the Short-Term

In the near term, the US economy and corporate earnings are expected to be influenced by a number of factors:

Pre-Tariff Purchases: Many businesses and consumers rushed to make purchases ahead of the tariff announcements, which negatively impacted first-quarter GDP.
Supply Chain Disruptions: Supply chain and transportation challenges are likely to lead to further earnings distortions as companies struggle to adapt.
Slowdown in Economic Growth: Morningstar’s US economics team has already forecasted a slowdown in real economic growth throughout 2025, with these disruptions only amplifying the trend.

If the stock market experiences another significant selloff, we recommend keeping some “dry powder” to return to an overweight position once valuations provide a more favorable margin of safety.

Should You Sell in May and Go Away?

There is a popular adage, “sell in May and go away,” as market returns tend to be weaker in the summer months.

Despite the current market trading at a reasonable discount to its fair value, we advise long-term investors to maintain a market-weight position.

Given the economic slowdown, the Federal Reserve’s likely decision to keep interest rates steady for now, and the ongoing trade negotiations, positioning in the market will be critical to protect against potential downturns.

To prepare for the likely turbulence in the spring and summer, we suggest the following investment strategies:

Focus on Companies with Durable Competitive Advantages: Look for companies that hold a strong competitive position, reflected by a wide or narrow Morningstar Economic Moat Rating.
Prioritize Low to Medium Uncertainty: Stocks with an Uncertainty Rating of Low to Medium are likely to perform better in volatile markets.
Seek Attractive Dividend Yields: Dividend-paying stocks tend to provide stability in uncertain markets.
Invest in Value Stocks: These stocks are positioned to benefit from the ongoing shift out of growth stocks.

Consider Defensive Sectors: Sectors such as utilities and consumer staples tend to perform better during periods of economic uncertainty.

Investment Recommendations Based on Style
Stock Style	Recommendation
💰 Value Stocks	Overweight: Trading at a 12% discount to fair value, making them an attractive opportunity
📊 Core Stocks	Overweight: Trading at an 11% discount to fair value, offering strong potential
📈 Growth Stocks	Underweight: Currently trading at a 3% premium to fair value, less attractive in the near term

Sector Valuations: A Shifting Landscape

Since our market update on April 9, sector valuations have generally increased in line with the market’s broader rebound.

However, some sectors have outpaced others in terms of recovery. Here’s an overview of sector valuations:

Energy Sector: Once a laggard, the energy sector is now the second-most undervalued sector, after communications. Despite ongoing challenges, such as lower oil prices, this sector remains an attractive option for long-term investors.
Consumer Cyclical and Real Estate Sectors: Both of these sectors are now tied as the third-most undervalued sectors, offering potential opportunities for investors looking to add undervalued stocks to their portfolios.
Consumer Defensive Sector: This sector remains the most overvalued. However, much of the overvaluation is driven by a few large companies, such as Costco, Walmart, and Procter & Gamble, all of which have relatively low Morningstar ratings. Excluding these three companies, the rest of the sector trades at a more reasonable 6% discount to fair value.
Utilities and Financial Services Sectors: Both sectors are also overvalued, with widespread overvaluation across many stocks in these categories.

Final Thoughts: Staying Balanced Amidst Uncertainty

As we head into the second quarter of 2025, the US stock market remains in a precarious position, with both risks and opportunities on the horizon.

While the 90-day tariff pause has provided temporary relief, the market is likely to experience heightened volatility as trade negotiations continue and economic growth slows.

Investors are advised to remain cautious but prepared, with a focus on value and core stocks in sectors that stand to benefit from ongoing economic shifts.

By maintaining a balanced portfolio and keeping an eye on valuation levels, investors can position themselves to navigate the turbulence ahead.