Where to Find Stocks to Buy in 2024

Susan Dziubinski: Let’s move on to some new research for Morningstar, and that’s your 2024 stock market outlook. Viewers can access your column via the link below this video. And in your 2024 outlook, you say that you expect this year to be “a return to normal.” What do you mean by that?

Dave Sekera: Well, in my opinion, I think 2024 is really lining up to be the first year after the pandemic that both economic conditions and consumer behavior are really past all of the disruptions and then those subsequent dislocations from those disruptions that were caused by the pandemic. So when you think about it, initially in the pandemic in 2020 and 2021, we had huge disruptions in both consumer and economic behavior. Consumers limited how much they were going out in public. A large percentage of employees such as us started to work from home, and we had some of the largest fiscal and monetary stimulus programs, I think, in U.S. history. Now then the past two years, 2022 and then 2023, there are a lot of dislocations that were caused by those initial disruptions. We had shortages. We had supply chain bottlenecks. All of that resulted in some pretty high inflation.

And then last year the Fed did begin to tighten monetary policy over that time frame, and fiscal stimulus programs started to expire as well. Now here in 2024, I think this is really the first year we’re past all of those disruptions and those subsequent dislocations. So consumer behavior, consumer spending, that’s getting pretty close to prepandemic norms. Employees are returning back to office, albeit on a hybrid schedule in many cases. And the Fed has paused tightening. In fact, we think they’re probably going to look to start easing this year and taking the foot off of the brake. And I expect the fiscal policy should be much more normal going forward as well.

Dziubinski: So then, Dave, what does the return to normal mean for stocks in 2024? Do you expect that the rally that we experienced in 2023 to continue to broaden this year?

Sekera: I’m looking for much more normalized patterns in both the economy and the stock market going forward. I think stock returns and fixed-income returns will also be closer to longer-term historical averages. I think investors specifically will be much more focused on more-traditional sector and company-specific fundamentals going forward. Now, I do think there is a risk to the market here in the near term in February and March. We do have companies starting to report earnings, and I think earnings for the fourth quarter are going to be OK. My concern here is I think a lot of management teams may look to use that as an opportunity to lower the bar for the market, probably provide some conservative guidance for 2024. I think a lot of people are of the same opinion of us that, while we’re not expecting a recession, we do think that the rate of economic growth will slow for the next three quarters. But looking further forward, we do expect that market returns will be much more broadly spread out across the market in 2024 than what we saw in 2023 where a lot of the returns were very concentrated.

Dziubinski: Let’s get a little bit into valuations. How do stocks overall look today, undervalued or overvalued?

Sekera: Actually neither. The market right now is trading really close to our fair value. And I actually want to take this as an opportunity maybe for viewers that haven’t watched us in the past to give them an explanation of how we think about market valuation. We actually use what I would consider to be a very bottom-up analysis. We take a composite of the valuations as determined by our equity analysts on over 700 stocks that trade on U.S. exchanges.

Now, a lot of other strategists use much more of a top-down approach. They typically will forecast S&P 500 earnings a year forward, and they use some sort of model or algorithm. Honestly, I don’t know how they actually really do it. They then slap some sort of forward multiple on top of that. And to me it always seems it’s much more of an exercise in goal seeking than valuation. And I think what our approach has done is really helped us keep a long-term consistent focus on value. And it’s really helped us in the past identify instances where we think the market has either—one, traded too far up to the upside, and other instances where the market had traded too far to the downside.

Dziubinski: Let’s look at stocks through the lens of market cap. Now, small-cap stocks look far more undervalued than mid- and large-cap stocks last year. Is that still the case in 2024?

Sekera: Yeah, that is definitely still the case. Small-cap stocks are still trading at about a 16% discount to our fair values, whereas large-cap stocks are just at a very slight premium over fair value. And then mid-cap stocks are trading at about a 6% discount. So in my opinion, I think actually small caps are positioned pretty well this year. I think that in a more normalized world going forward, more normalized on what we’ve seen over the past four years, I think that will give them the opportunity to perform pretty well and see that valuation gap close.

Dziubinski: Now, what about value versus growth versus core stocks, Dave? How do valuations break down there?

Sekera: Value stocks, they certainly lagged behind the market last year. They’re still trading at about a 10% discount to our fair values. Growth stocks are essentially at fair value right now, and then core stocks trading at about a 4% premium to our fair value. So if you remember at the beginning of 2023, we had actually advocated for a barbell-shaped portfolio at that point in time; we were recommending investors to overweight both value and growth and then underweight core. But now that growth has soared so much in 2023, has gotten back up to our fair values, I think now is a good time to be market-weight growth, but I would still remain overweight value and I’d underweight core in order to be able to be that overweight in the value category.

Dziubinski: And then finally, let’s parse the market by sector. First, let’s talk about technology stocks, which did very well in 2023. How do valuations look there today?

Sekera: Tech, interestingly, started 2023 as actually one of the most undervalued sectors. It’s skyrocketed. The Morningstar Technology Index is up 59% for 2023. Now at this point, we think it’s actually gone too far to the upside. It’s now trading at a 9% premium to our fair value. Still a handful of stocks in the tech sector that we think are undervalued, but for long-term investors, the sector as a whole is trading just too high in our view. And I actually think now is probably a pretty good time to take some profit there and underweight tech.

Dziubinski: Communication services was the most undervalued sector coming into 2024. Why do you think that is?

Sekera: A couple of different reasons in communication. So first, Alphabet, the parent of Google, accounts for 42% of the communications index in and of itself just because it’s just such a huge market cap. Now, Alphabet fell way too far in 2022 in our view as compared to our valuations. We did have a very strong rebound here in 2023, but we think that rebound still has further to go. It’s a 4-star-rated stock and trades at a 16% discount to our fair value.

Now, secondly, I think the market is still just overly pessimistic on the long-term outlook for more of the traditional communications and media names. So for example, we’ve talked about AT&T and Verizon numerous different times. Those are both 4-star-rated stocks, still traded 26% discount to our fair value. And we do expect that going forward that industry will probably start to act more like an oligopoly and we’ll see margins improve there over the next couple of years. Another one I’d highlight is going to be Comcast. That’s a 4-star-rated stock, trades at a 28% discount. We think the market’s just overestimating the amount of deterioration in its traditional TV business and probably underestimating the growth in more new broadband customer gains. Overall, based on valuations, I would still remain overweight communications. The sector overall trades at about 11% discount to our fair values.

Dziubinski: What other sectors stand out to you as particularly appealing from a valuation perspective right now?

Sekera: The other sectors that I would look to probably overweight now are going to be real estate and energy. Both of those are trading at a 8% discount to fair value, as well as basic material and utilities. And both of those are trading at a 7% discount. The quick takeaway on each sector: In real estate, still a lot of concerns about office space and the valuations there, but what happened is that really just pulled down the entire sector. We saw commercial real estate just across the board get pulled down. I think a lot of those have fallen too much of the downside. Plus, I think in 2024, real estate should benefit from a tailwind as we expect interest rates to decline.

And basic materials, I think, yes, the economy is slowing here for the next couple of quarters, but I think there’s just too much pessimism for the long-term outlook there, so we see a number of different opportunities.

Energy, that was actually the most overvalued sector a year ago, but it’s one of only two sectors that fell last year. Starting to see a lot more interesting opportunities in energy.

And then utilities was the other of the two sectors that fell last year. We think that sold off too much, especially last fall when interest rates were rising, and now with interest rates expected to continue to keep coming down, that’s going to be a tailwind. And we just still see very strong fundamentals for the utility sector overall.

Dziubinski: Given your market outlook, Dave, how should investors be thinking about their portfolios in these early days of 2024?

Sekera: I think, overall, your portfolio allocations right now based on your long-term, targeted weightings should be right at those targets. In fact, personally I wouldn’t either overweight or underweight either equity or fixed income. I think it’s really much more positioning within equity and positioning within fixed income. Within equity, I’d be overweight value, overweight small caps, and then by sector, we’d be overweight exactly the same that we just talked about, communications, basic materials, real estate, and utilities. And then in order to overweight those, I would look to underweight tech, industrials, and consumer cyclicals.

And then within fixed income, based on our outlook, I’d still stick with longer duration positions. Our economic team forecasts long-term interest rates should decline over the course of 2024 and into 2025. I think investors will be able to benefit over the next couple of years from both the relatively high interest rates we have now as well as price appreciation. Whereas in the short end of the curve, while you do get relatively high rates right now, our economic team projects that the Fed will start cutting rates this year and into next year. So those short-term rates will start coming down.

This is an excerpt from the Jan. 8, 2024, episode of Monday Morning Markets with Morningstar’s Dave Sekera. Watch the full episode, 5 Undervalued Stocks to Buy During Q1 2024. See a list of previous episodes here.