NEW YEAR MARKET & ECONOMIC OUTLOOK
December 31, 2020
2021 Outlook
Less Stress, More Fun in 2021!
Last year at this time, I called 2020 the year of “Resiliency Amongst Uncertainty.” Like everyone else on the planet then, I had never heard of COVID-19 and a world overtaken by a pandemic was the last thing on my mind. So, I had no idea how right I was expecting investor uncertainty and market resiliency this year. We all know now 2020 has been a year of unprecedented uncertainty, stock price volatility and amazing market resiliency. Good-bye 2020 and HELLO 2021! As always with the new year just hours away, it is time for my New Year Outlook.
“Less stress and more fun in 2021” is what I am calling next year. Two huge contributors to investor’s anxiety in 2020, COVID and the presidential election, are thankfully likely to bring less stress in 2021. November brought high hopes for a coronavirus vaccine with two promising cures: one that showed a nearly 95% efficacy and another indicating 90% effective and, after a rocky transition to the White House in January, Election 2020 is history. No doubt other issues we can think of, and some we can’t, will surface to cause investors concern next year. So, expect the usual bouts of spikes in market volatility in 2021. Again, it’s that time of year so here’s my insights and forecast for the global stock market and world economy in the new year.
2021 U.S. Stock Market Outlook
I have said for decades that earnings matter most when evaluating stocks and the major stock market indexes. Expectations are for a sharp rebound in earnings in 2021. With a $175 earnings target for the S&P 500, my outlook is for a higher stock market next year. However, how much higher depends on a lot, especially investor confidence. Without a big boost in confidence, the stock market may not deliver high returns in 2021. Perhaps the foundation of fundamental stock analysis is the Price-Earnings Ratio (P/E ratio). The P/E ratio is the ratio between current share price and per-share earnings. When dividing earnings into price, we get a “multiple” – in other words, how much investors are willing to pay for expected earnings. The more confidence, the more the multiple. Since the early 1970’s, the average P/E for the S&P 500 has been about 20. Applying that historical P/E to earnings expectations of $175 for the S&P 500 next year, we get 3,500. That is lower than where the index is today (3,756 December 31,2020). You say, “That doesn’t sound good!” In some ways, 2020 stock market action borrowed from 2021. Better earnings in 2021 have been “priced in”. So, to get a higher stock market next year (S&P 500) we will need either even higher earnings OR greater confidence (higher multiple). A P/E of about 23 takes the broad stock index to 4,000. That is about a 7% gain in the S&P 500 from today, but also a P/E ratio about 15% above the norm. As noted above, higher investor confidence in stocks should yield a higher rate of return to stock investors.
A common question among stock investors looking ahead to next year is: Will the “rotation” continue? It’s a good question, and a macro market dynamic you will likely hear much about. So, what does this mean? The question speaks to which class of stocks are gaining the market’s favor. Specifically, will “reopening/recovery” stocks outperform the “stay-at-home” stocks? Generally, this rotation phenomena is about “value” vs. “growth”. Clearly, the “coronavirus bull market” winners were the stay at home stocks. Think Peloton, the stationary bicycle company. Those type of stocks jumped as economic sensitive stocks, such as travel and restaurants, were dumped. This situation has been in place since the outbreak of the global virus. During this time growth stocks dramatically outperformed value stocks. Then came the early November news of highly effective COVID-19 vaccines and the delivery of millions of doses in recent weeks. Immediately, the rotation began – COVID beneficiary stocks that had gone up so much began to fall as stocks that were deeply beaten down rose sharply. So, will this rotation continue and be a theme in 2021? The virus still controls the U.S. economy, and therefore, will determine when economic sensitive stocks rebound with earnest. Speaking of the economy next year, more on that after my thoughts on foreign equity markets in 2021.
2021 Global Market Outlook
2020 was both a surprise (in more ways than one!) and not a surprise. As I wrote in my 2020 OUTLOOK, the world markets would be “resilient amongst uncertainty.” Looking forward, more of the same is likely. The global economies are in the early post-recession recovery phase of the cycle, which implies an extended period of low-inflation, low-interest rate growth that favors stocks over bonds. One of the biggest surprises of last year is that global equities, from late November, gained around 14% since the beginning of the year-an outcome few would have predicted or expected during a global pandemic. With the U.S. election behind us and effective vaccine deliveries on the way, bullish investors pushed the S&P 500 Index to record highs into year’s end. This year, I expect investors will experience “Less stress and more fun in 2021.” This prediction is based on my view that stock supporting catalysts remain. Generally, interest rates are likely to remain near all-time lows as the Federal Reserve has recently reiterated its near zero interest rate policy. Consumer confidence is likely to improve. Retail sales, especially via e-commerce, are strong, corporate earnings are rising and investor sentiment is high as the TINA effect (There Is No Alternative) prevails.
Foreign focus in 2021 should be on emerging markets (EM). From an international equity allocation point of view, I recommend an overweight position to EM stocks. I see them as principal beneficiaries of a vaccine-led global economic upswing in 2021. Other positives I think will benefit EM stocks are a likely flat to weaker U.S. dollar and a more stable trade policy under the Biden administration. Secondly, I expect strong stock gains from Asian country stocks (excluding Japan). Asia ex-Japan countries have effectively contained the virus – and are further ahead in the economic restart. I expect the region’s tech orientation allowing it to benefit from structural growth trends. A surprise stock market move may come from European equities. However, I see unique risks in Europe that may stifle stock gains. The Eurozone has relatively high exposure to financials pressured by low rates. It also faces structural growth challenges, even given potential for catch-up growth in a vaccine-led market and economic revival. Germany, France, Italy, Spain and the UK are all embarking on new nationwide lockdowns. Their recoveries in 2021 will likely be boosted by the huge monetary and fiscal stimulus policies adopted by their central banks governments.
Overall, these are my asset class implications for 2021:
- Equities should outperform bonds.
- Long-term bond yields should rise, though with steeper yield curves likely limited by continued low inflation and central banks remaining on hold.
- The U.S. dollar will likely weaken given its countercyclical nature.
- International stocks to outperform given their more cyclical nature and relative valuation advantage over U.S. stocks. Overweight EM.
- The rotation to value stocks continues but they do not outperform the growth class.
U.S. Economy in 2021
As I mentioned above, the virus still controls the U.S. economy and will in 2021. The good news as of late is the development of promising vaccines. COVID-19 vaccine optimism and in turn a “return to normal” for 2021 has dominated investment news headlines and changed investor’s behavior. This is potentially the beginning of an economic recovery set to accelerate in 2021. I point to dual forces that could propel an economic rebound – shifts in behavior from consumers and corporations – that I expect to generate significant growth for the economy next year. It is expected that as much as $4 trillion in pent-up demand for goods and services from consumers could be spent in 2021 if they begin to feel like there’s a return to normal. Then there’s corporations. With historic highs of corporate cash on their balance sheets, an increase in corporation spending could also fuel economic growth.
After 2020’s weakest economic period since the Great Depression, the outlook for the economy in 2021 is less rocky and, at least, a little more rosy. I must reiterate, all depends on COVID-19. While a return to pre-pandemic GDP levels is unlikely, a 3-4% rate of growth in the U.S. economy is expected. A continued improvement in the jobs market it critical. No doubt, the additional economic stimulus package will help jobs and boost the economy at least short-term. Our economic weakness began with the virus in 2020. Let’s hope it ends with the vaccines in 2021.
Global Economy in 2021
The consensus forecast for global economic growth for 2021 is 5.4%. I expect more. Following a steep decline in early 2020, the world economy enjoyed a sharp rebound that began in May and remains on track to surpass pre-pandemic GDP levels by the end of 2021. This sets the stage for strong post-recovery growth this year. Emerging markets, notably China and India, along with the re-opening of Europe, leads me to expect a macro global economic growth outlook that exceeds consensus. I am less bullish on Europe in 2021. After declining by 3.8% and 11.8% in the first and second quarters of 2020, the Eurozone’s real GDP rebounded strongly by 12.7% in the July to September quarter, making up about half of the contraction in the first half of the year. In summary, a global GDP growth rate of 6% or higher is my prediction.
Whether global investments appreciate greatly and economies rebound strongly, or not, my hope for 2021 is the world’s population has a healthy, virus-free year!
Happy 2021!
Wishing You a Happy & Healthy New Year!
John
Call me if you have any questions. I am always happy to help!
John J. Gardner, CFP®, CPM®