5 Pieces of Good News for Investors as 2023 Wraps Up

Ivanna Hampton: Welcome to Investing Insights. I’m your host Ivanna Hampton. Many investors watched 2023 unleash highs and lows. Interest rates rose and stopped, while inflation dipped, AI stocks boomed, and the 10-year U.S. Treasury yield rode a roller coaster. Tom Lauricella will review this year’s market trends and discuss what to expect next year. He is Morningstar, Inc.’s global markets editor and Smart Investor Newsletter editor.

Good to see you, Tom.

Tom Lauricella: Great to be here.

What to Expect From the Fed in 2024

Hampton: The Fed held interest rates at their final meeting of the year, as expected. They also signaled three cuts next year. The markets rallied. What do you make of this enthusiasm?

Lauricella: The market certainly liked what the Fed had to say. They probably took it a little bit further than what the Fed had to say, and in fact, maybe even further than the Fed might potentially want. The markets are pricing in a pretty aggressive series of rate cuts next year. But, either way, the Fed has made a pivot to saying that they’re going to be lowering rates as their next move, and that’s a change. That’s a significant one for the markets as long as it sticks, as long as inflation doesn’t start to creep back up. That means that this incredibly aggressive rate hike cycle is likely over. And, so, there’s definitely some good news there for the markets, and it allows for some repricing to that lower-rate environment.

Inflation and Housing

Hampton: Morningstar’s senior U.S. economist Preston Caldwell is predicting six rate cuts next year. He says declining inflation has given the Fed confidence to pivot, yet housing inflation is still high. How can the Fed win the fight against inflation with housing as a hurdle?

Lauricella: Well, the idea here is that housing costs, as are reflected in the inflation numbers, are very slow-moving and that they operate with a lag to a large degree for the rest of the economy. Those numbers, the idea is that they will start to turn in the right direction for the Fed. So, the Fed is looking forward, and the Fed and a lot of other economists see positive developments in the inflation numbers that suggest that inflation will continue to moderate. Not clear yet that it will get to the Fed’s 2% target. Preston Caldwell thinks that it will. Other folks in the markets aren’t quite so certain. But for now, though, even something like those housing costs ought to be going in the right direction in the near term.

Dropping Bond Yields

Hampton: And the 10-year U.S. Treasury flirted with a 5% interest rate, but it has dropped. Can investors breathe a sigh of relief, Tom?

Lauricella: I think what investors need to remember is that even though interest rates, bond yields in particular, have come down from their highs of just a couple of months ago—we were looking at 17-year highs in Treasury yields—that we’re not going back to the rate environment that we were in. So, yes, for bond investors, it’s good news, rates have come off their highs. Also, yields are still at attractive levels, the most attractive levels that they’ve been in years. At the same time, when it comes to additional, say, price returns on your bond mutual fund, that’s going to be a lot harder to come by. And we’re not likely to go back to the kind of interest rate levels that we saw prior to the Fed’s rate-hike cycle.

The Magnificent Seven Stocks

Hampton: Let’s talk about the so-called Magnificent Seven stocks. We talked on the podcast midyear about Nvidia NVDA, Apple AAPL, and others driving an unprecedented rally. What’s their story now?

Lauricella: Those stocks continue to play a huge role in how the market is performing, thanks just simply to their size. The good news for the market is that those stocks have, for the most part, held in pretty well. I mean, Apple is approaching a new all-time high, and others are, for the most part, holding in well.

The challenge is that some of them are either fairly valued, such as Microsoft MSFT and Nvidia, or overvalued in the case of Apple. But the real good news for investors here is that the rally has broadened out recently, particularly as the Fed has signaled that it is looking likely to cut rates next year. So, you’ve seen this kind of trend that many strategists have been calling for, looking for, in order to say that the market rally would be more sustainable, which is a broader participation. So, it’s not just the Magnificent Seven leading returns, it’s on a much wider basis for stocks, mid-caps, and small caps, in particular, which have been doing quite well lately.

Nvidia Stock vs. Cisco Stock

Hampton: Morningstar recently compared Nvidia to a high-flying stock from the dot-com bubble. What makes Nvidia and Cisco CSCO similar and different?

Lauricella: The comparison there really starts with returns and valuations and just general sentiment. So, back in 1999, Cisco was one of the hottest stocks around. It was riding that dot-com bubble. And then, unfortunately for investors who bought into it that year, the stock cratered when the tech stock bubble collapsed and is yet to return to those highs amazingly all this time later.

Nvidia is a stock in a very hot space with AI. Its chips are critical to a lot of the technology that the AI needs to run. And so, it’s seen massive returns. Its valuations on most measures are pretty high, although Morningstar thinks right now that it’s just fairly valued, not overvalued. But there are some important differences, different types of product cycles. Nvidia, their product cycle is much shorter. It also really has a dominant role. It’s hard to replace where they sit in the ecosystem. And they’ve also developed the whole ecosystem of developers around their chips. So, there are some similarities on the surface. But as soon as you get under the hood, maybe there are some concerns there. But it does look like it’s a different story.

Who Is Next to Benefit From AI?

Hampton: The AI boom celebrated a milestone this year, marking one year since ChatGPT made a public debut. You wrote that the early winners are chipmakers like Nvidia. Talk about who could lead the next wave.

Lauricella: Nvidia is definitely going to continue to be a leader, like we said. But this is one of those things where there are a lot of names out there than just Nvidia making the chips. There’s a whole ecosystem of companies that are looking to take advantage of this and can take advantage of this. You’ve got software companies, obviously, Microsoft, in particular, with its huge investment in OpenAI. Then you have companies like other chipmakers. And you have companies that are putting AI to work, like Salesforce CRM, for example, which is integrating AI into their products. So, it’s important for investors to look beyond just Nvidia at the whole ecosystem of stocks. I mean, the reality is that it’s looking like AI is going to be part of just everybody’s business plans, just like the internet is today.

Outlook for Obesity Drug Stocks

Hampton: Let’s talk about another big story this year: the competition among drugmakers producing obesity drugs. What’s Morningstar’s take and recommendation for investors?

Lauricella: This has been another big story here in 2023. The two leaders in this space have been Eli Lilly LLY and Novo Nordisk NVO. Lilly, in particular, is way out ahead with its drugs and Novo as well. But both stocks are trading at quite expensive valuations, according to Morningstar. And so, at this point, it looks like it’s going to be increasingly competitive in a crowded marketplace. Investors who are putting money to work in pharma, thinking perhaps this is one of their key drivers of particular companies, Morningstar is looking at some other names, in particular Roche RHHBY, which is significantly undervalued, and it’s just made a big investment in this space. So, it’s another area where investors can do a little bit of digging and find some names that are more attractively priced.

The Bond Market in 2023

Hampton: And 2022 went down as the worst year for bonds, right? So, how did 2023 treat bonds, Tom?

Lauricella: It was looking kind of rough there for a little bit this fall. We were flirting for a little while with an unprecedented third-straight year of losses in the bond market. However, as it began to look like the Fed was not going to raise rates anymore and is now pivoting toward cutting rates next year, that’s really bailed out the bond market. So, you’ve got bonds in positive territory. You’ve got those with a little bit more credit risk, like high-yield bonds, bank loans, and corporate bonds in general. Those in particular are doing quite well. So, it’s turned out to be a pretty good year for bonds. Low- to mid-single-digit gains, not bad. Still doesn’t get us back to where we were prior to that beating that everybody took in 2022. But it’s been some good news on the bond front, finally.

2024 Outlook

Hampton: Let’s talk about 2024. What trends should investors watch for?

Lauricella: Well, the big one is still going to be the Fed. As we started off saying, the markets are looking for a pretty aggressive set of rate cuts—six rate cuts next year. The Fed is saying that’s not going to be the case, that it expects three. Perhaps we could see some disappointment in the markets if it looks like the Fed isn’t going to be able to start cutting rates as soon as the market expects by the middle of next year. So, the Fed will continue to dominate the markets. Of course, we’re going into an election year that can add all kinds of oddities into the markets and the investment landscape. We’ll have to see on that front. Geopolitical issues or risks are still out there. And then, we have these other trends that we’ve just talked about in terms of things like how will the AI boom play out. That’s a big one. And as I referred to earlier, will the stock market rally continue to broaden out? Will it finally be a year for small-cap stocks after many years of underperformance? These kinds of questions are going to be interesting to watch.

Hampton: Well, thank you, Tom, for your year-end markets review. Happy holidays.

Lauricella: Thanks.

Hampton: That wraps up this week’s episode and our final one of the year. Investing Insights is going on a break. We’ll return on Friday, Jan. 5. Subscribe to Morningstar’s YouTube channel to see new videos from our team. Thanks to senior video producer Jake Vankersen and lead technical producer Scott Halver. And thank you for watching Investing Insights. It means a lot.

I’m Ivanna Hampton, a senior multimedia editor at Morningstar. Happy holidays.