Although market gains have been subdued recently, it’s been a glorious bull market.
The S&P 500 recorded the second straight calendar year of 20%-plus returns in 2024 for the first time in 26 years. The index has risen over 70% since the bull market began in October of 2022. That’s an annualized return, through January, of over 24%, two and a half times the index’s historical average annual return.
While the recent high returns make the market seem expensive, a look under the hood tells a different story. This bull market has been driven higher by technology and the artificial intelligence catalyst. Without a handful of large technology companies, the bull market returns so far would be quite lame.
In fact, from the beginning of 2022 through January, the “Magnificent 7” stocks accounted for 55% of the S&P 500 gains. Without Apple (AAPL), Microsoft (MSFT), Alphabet (GOOG), Amazon (AMZN), Nvidia (NVDA), Meta (META), and Tesla (TSLA), the bull market returns would be less than half.
But things are changing. There are good reasons to believe the relative returns of the rest of the market should vastly improve.
The market rally started to broaden out last summer. Utilities and REITs came on strongly in the second half last year as the interest rate narrative improved. Cyclical and energy stocks led the market higher after the election. So far this year, the best performing of the 11 S&P 500 market sectors are Materials, Financials, Communication Services, and Energy. In fact, Information Technology is the second worst-performing sector YTD.
Other stocks are picking up the slack while technology is wobbling. The grossly lopsided performance couldn’t last. And there’s more to the story than just sector rotation. Earnings are catching up.
Average earnings growth on the S&P 500 is expected to be 14.8% in 2025 (according to FactSet). That’s the strongest growth in years and far above the ten-year trailing average growth rate of 8%. The difference comes from the growth in non-technology companies. In 2024, the average earnings growth rate of the “Magnificent 7” exceeded that of the other 493 companies by 28%. That difference is expected to fall to just over 7% in 2025.
There are still good reasons to be bullish on technology and artificial intelligence over the next several years. But other sectors of the market are overdue for stronger relative performance. And now the rest of the market has stronger earnings, momentum, and pent-up demand.
Even though the market is high, it’s high because of AI, which has earnings growth to justify higher valuations. For the rest of the market, valuations aren’t high, and the rally may just be getting started. Here are two great stocks to consider.
2 Undervalued Stocks That Are Just Getting Started
McKesson Corporation (MCK)
The pandemic aftermath made us acutely aware of the importance of supply chains, as disruptions caused short supplies and skyrocketing prices. Efficient distribution is what makes this whole consumer economy work.
McKesson Corporation (MCK) is a leading domestic wholesaler of branded, generic, and specialty pharmaceutical products. The company operates a supply chain that delivers products from 1,300 drug manufacturers to over 180,000 points of dispensation throughout the country. It supplies about one-third of the U.S. drug distribution market.
McKesson buys drugs from manufacturers, delivers them, and resells them to retailers at a profit. Established in 1833, the company has been honing the process for nearly two centuries. Naturally, it has strategic partnerships with companies like CVS (CVS), Walmart (WMT), and Rite Aid (RAD).
The extensive distribution network and enormous scale give McKesson tremendous bargaining leverage with suppliers and customers that can’t be easily duplicated by would-be competitors. That’s why the business is an oligopoly. McKesson, along with Cencora Inc. and Cardinal Health, account for 90% of the frug wholesale distribution market in the United States. In addition, there are very high switching costs among the providers, so they rarely lose business to the other two companies.
MCK has a stellar track record over the last several years. Over the last three- and five-year periods, MCK has returned 127% and 270% respectively, compared to 49% and 95% for the S&P over the same periods. But the stock has recently endured a rare stumble.
McKesson serves a market that grows all by itself because of the aging population. The stock has temporarily pulled back over the last six months and could be poised for more stellar returns in 2025.
Ally Financial Inc. (ALLY)
Ally Financial is the leading all-digital banking company in the U.S. with 3.3 million customers and over $100 billion in loans. The primary revenue source is automotive loans (over 70%), but it is also diversified in auto insurance, commercial lending, mortgage financing, and credit cards.
The company was the financial segment of General Motors (GM) where it developed a 100-year-old, fully developed auto loan business. It was spun off in 2009 during the financial crisis as part of GM’s bankruptcy reorganization. The company has since focused on the online business.
Ally is still a relatively small bank among the big players in the country. But it is becoming very well-established in the high-growth, online banking part of the business. It focuses on this area more than established banks and may grow into a much bigger player in the years ahead.
A big reason to buy ALLY now is because it’s cheap, much cheaper than its peers. Despite the recent rally and the market at highs, ALLY sells at just 8 times forward earnings and 0.93 times book value, both valuations are well below those of the market averages. But there’s a reason it’s cheap.
Ally is highly leveraged to the auto market where things have been challenging. Consumers are strapped from inflation and loan rates are still high. The dynamic has led to flattening sales and an increasing number of defaults. ALLY plunged over 20% in early September after the company disclosed that loan defaults were worse than expected.
But the stock has been recovering and is up 10% YTD. Also, the latest earnings reports featured lower loan losses than previously expected and a positive prognosis going forward.
Other financial stocks that had performed on par with ALLY have already soared to new highs. ALLY should have some catching up to do.
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