3 Stories That Moved the Markets in 2023

Susan Dziubinski: Let’s walk through what happened in the market in 2023.

Dave Sekera: If you remember, according to our valuations coming into 2023, we noted that we thought the market was significantly undervalued. And when I look at the market over the course of this year, I think there are really three main phases that the market underwent. First, at the beginning of the year in January and February, the market did start moving up, but then we had the collapse of Silicon Valley Bank and Signature Bank, and then even Credit Suisse, one of the major international banks, failed, and the market did drop pretty hard in March.

The second phase began in the spring and the summer, and that was the emergence of the “Magnificent Seven” and artificial intelligence. And so we saw the market march higher, in fact, getting all the way up toward fair value in the fall. And then the third phase was as interest rates continued to climb over the course of the year, there really wasn’t a problem until we started getting up toward 5%, and the markets didn’t like that. The markets sold off once we got in the upper four handle, and especially those interest-rate-sensitive sectors fell pretty hard. And that sent us back down into undervalued territory in October as interest rates then started to subside.

The Santa Claus rally came early this year, starting in the beginning of November. And it’s continued here now that the Fed is shifting toward a more accommodative policy. And, at this point, when we look at the market, it’s essentially trading right back at fair value once again.

Dziubinski: Let’s unpack a few of these stories. Remind viewers why we saw a few bank failures in 2023 and then what the implications are for the banking industry moving forward.

Sekera: Well, you have to remember, bank failures are almost always a lack of confidence in the solvency of a bank by its depositors. So in this case, at Silicon Valley Bank, they had a huge amount of long-term debt on their balance sheet that they bought when interest rates were at their lows. As rates started to begin to rise, the value of those long-term bonds fell, and that left the bank with just exceptionally large losses in its hold-to-maturity accounts. Now, some depositors noticed, and they started getting to be nervous that the bank was no longer well-capitalized and started to pull their money out, which then once other depositors saw them pulling their money out, they decided to get their money out as well. And it just got to the point where the bank wouldn’t be able to repay all those depositors who were pulling their money out.

So, the Fed had to come in, shut the bank down until it could be restructured and sold off. And, of course, that then started the chain. Once Silicon Valley Bank failed, everyone started to look to see what other banks had similar losses in their balance sheets and started pulling money out. Credit Suisse had some slightly different issues, but once deposits there started getting pulled out, that became a self-fulfilling prophecy there, and that bank failed as well.

The end result is that investors decided, and stock investors specifically didn’t want to risk seeing the value of their stocks plummet, so they then sold first and decided to ask questions later, and that sent the entire U.S. regional sector down. As a lender of last resort, the Fed did step in. They devised a couple of different funding programs for banks that had these hold-to-maturity losses, that then stabilized the banking system. In our view, throughout most of this, we noted that the U.S. banking system, specifically the regional banks, which were under stress but fundamentally they weren’t broken. And so we do think that the markets have pushed these stocks down for the regional banks too far during that selloff, and a lot of them are still very undervalued today.

Dziubinski: Turning to the second big story of 2023, and that’s definitely AI and the “Magnificent Seven.” Do you expect these seven stocks to continue to dominate markets again in 2024?

Sekera: We don’t. We think that for the most part, these stocks have really run their course. So, coming into the year, six of those seven were significantly undervalued. They were rated either 4 or 5 stars, but now five of them are in that 3-star territory, meaning we think they’re pretty close to being fairly valued. And they’re rated 3 stars, with Apple AAPL being the only one that’s now overvalued and rated 2 stars. And lastly, Alphabet GOOGL, the parent of Google, is still undervalued and rated 4 stars. But for the most part, I think that that’s really a story of 2023 and not going to be a story of 2024.

Dziubinski: And then again, the last story is really interest rates in 2023. In your midyear bond market outlook, you suggested that investors start to lengthen their durations, and you actually reiterated that view just on last week’s show. So, given what we’ve heard from the Fed, what are Morningstar’s expectations for long-term interest rates in 2024?

Sekera: It was really some pretty crazy price action in the bond market after the Fed meeting. And to be honest, rarely have I seen moves like that in the bond market in such a short period of time. When I look at the 10-year Treasury, that rallied on Wednesday, the yield fell about 17 basis points, dropped to just above 4%, then it declined another 10 basis points on Thursday to 3.93%, and that’s where it ended up the week. Looking forward, we’re still holding to our forecast. We’re still looking for the 10-year to average about 3.6% over the course of 2024. But then we also expect it’ll continue to keep coming down, and we’re looking for an average of 2.75% percent over 2025.

This is an excerpt from the Dec. 18, 2023, episode of Monday Morning Markets with Morningstar’s Dave Sekera. Watch the full episode, 6 Undervalued Stocks to Buy After the Market Rally. See a list of previous episodes here.