Stocks Hit Record Highs, Erasing Bear-Market Losses

What a change! He Morningstar US Market Index reach a record on Wednesday, January 24, meaning the stock has already recouped all losses that started accruing in early 2022.

The rise of technology stocks pushed the index over the line into record territory. The S&P 500, which is more weighted toward large-cap growth stocks, hit its record high on Friday. The gap between the two records is another indication of the enormous impact that mega-cap tech stocks are having on the market.

After returning a surprising 25.8% in 2021, the Morningstar US Market Index plummeted in 2022 and ended the year down nearly 20% as persistently high inflation triggered rapid interest rate hikes by part of the Federal Reserve. Those headwinds pushed stocks to “near their deepest discounts to our valuations over the past decade,” says Dave Sekera, chief U.S. markets strategist at Morningstar.

But 2023 was a different story. In the end, shares rose more than 26% and traded much closer to Morningstar's fair value estimates. The new market high comes just over two years after the US market index hit its previous record on January 3, 2022.

Why did stocks rally?

Markets started 2023 on the right foot, as a long-awaited recession failed to materialize, the labor market remained strong, consumers continued to spend, and pandemic-era distortions began to dissipate.

According to Sekera, the rise of artificial intelligence technology and the rise of the “Magnificent Seven” drove markets higher in the spring and summer. In the first half of the year, the US market index returned 16.5%, despite the bank failures that shook investors in March.

It all came crashing down in July as markets absorbed the Federal Reserve's message about “higher for longer” interest rates. Bond yields soared to their highest levels since 2007 and stocks faltered.

But it wasn't long before a series of encouraging economic data, accompanied by increasingly dovish speech from Federal Reserve officials, sparked a bond market rally, and yields fell sharply. That reversal sparked what analysts call an “everything rally,” in which stocks, commodities and other financial assets (including cryptocurrencies) gained strength as investors bet that the Fed’s rate cuts are on the way. just around the corner.

The market stumbled in the early days of 2024, but soon recovered as technology stocks soared amid expectations that the Federal Reserve might not cut rates. quite as quickly as investors expected.

Where are stocks headed this year?

Looking ahead, Sekera says the stock market is in a very different situation than it was at the beginning of 2023. He says economic growth is expected to slow again, but “that's the only similarity.”

The stock market is now trading just below fair value, unlike when it was significantly undervalued in early 2023. Monetary policy is now expected to ease rather than tighten. Inflation is finally cooling. Many of the distortions and disruptions caused by the COVID-19 pandemic have finally subsided.

In 2023, much of the stock's momentum was concentrated in the Magnificent Seven. Sekera says the critical determinant of whether the rally can continue is whether those gains can spread to other sectors and other types of stocks. He explains some good news for investors: "This is already happening." He points to consumer cyclicals, industrials and real estate as sectors that are seeing huge returns. Mid-cap and small-cap stocks are also rising.

Sekera warns of a possible pullback in February and March as earnings season progresses. He says the concern is not that companies will disappoint on earnings, but rather that management will be inclined to issue more conservative guidance (and, as a result, keep expectations low) as they look toward an economic slowdown in the second half. half of the year. .

As that slowdown approaches, the Federal Reserve is expected to begin cutting interest rates.

So where does that leave investors? "Some of the best opportunities we see for 2024 are stocks that are highly correlated to interest rates," Sekera says. She points to utilities and real estate as sectors that meet that criteria. There are also opportunities in value stocks and small cap stocks.