The last time we experienced a major pandemic 100 years ago, Wall Street followed up with the “Roaring 20s.”
Needless to say, there’s no guarantee of that kind of rebound after Covid-19, and the economy might have more dark days ahead in 2021. Still, the brightest hopes on Wall Street are for a recovery from the pandemic and a surge in demand for all the fun stuff we’ve been missing this year, like flying in a plane to see friends and family, taking in a ballgame, or simply heading to the local restaurant for dinner. You don’t realize how much those things mean until you can’t have them. And the impact on business owners and their employees has been devastating.
As one of the weirdest and most harrowing years in our lives comes to a welcome end, no one on Wall Street can say with any authority what’s next. The prediction game isn’t a good one to play even in normal times. And we’re exiting a year when the market whipsawed from three-year lows to all-time highs amid coronavirus, the election of a new president, zero interest rates, and worldwide recessions.
Even if you try to pin down one of the most well-known investment bankers in the country about what’s next, you can’t get a definitive answer.
“We don’t have any experience with this,” Fed Chairman Jerome Powell told the media at his most recent press conference December 16, when asked about the short-term economic outlook as Covid-19 cases spike. “The next few months are likely to be very challenging.” He did say there may be “light at the end of the tunnel,” and brought up the chance of “another long expansion,” but was careful not to predict that.
Vaccine distribution, the impact of a fiscal stimulus, and how quickly the economy reopens remain big questions going into the new year, making it very difficult to forecast anything without a big caveat or two. Even the makeup of the U.S. Congress isn’t clear nearly two months after the general election. People won’t find out till January 5 who controls the Senate.
That said, there are ways to put some pieces together and come away with a basic sense of what to look for on Wall Street and Main Street in 2021. We’ve broken it down into six big-picture segments.
Covid-19: Case Counts vs. Vaccines
Arguably, 2021’s path depends on a shot in the arm. Or two, as it appears we’ll require for now. Strong data and quick approval of the first vaccine, marketed by Pfizer PFE -1.2%
(PFE), set the Q4 tone for Wall Street, sending indices to new all-time highs. By mid-December, people in the U.S. and Europe were beginning to get vaccinations, lifting hopes that at some point we could all come out of our lockdowns and go back to normal lives.
But the 2020 holidays were marked by record case counts and fresh lockdowns, making for a push-pull dichotomy between current struggles and a potentially bright future.
Clearly the market is looking beyond the vaccine to all the great things that might happen. The problem is, no one knows how long this will take, and the logistics could be tricky. Already, there are concerns about whether enough doses will be available quickly enough to get herd immunity into gear. It could be a logistical circus, so it’s important for investors not to get too caught up in the initial euphoria. This is the long game, not a one-round playoff.
Everyone talks about the PFE and Moderna (MRNA) vaccines because they’re in the vanguard. Don’t forget that other companies also may be close to filing. The Johnson & Johnson JNJ +0.5%
(JNJ) vaccine, if successful, could help with logistics since it only requires a single shot. The company says it could have interim data by late January.
With the vaccine situation unclear, it’s hard for economists to pin down the outlook with any real authority. That’s a heavy lift even in a normal year, which might remind some people of the old joke about economists predicting 10 of the last six recessions. As the virus continues its grip on the economy, everything is up in the air.
Still, the Fed is taking a shot at it, coming out in mid-December with new economic estimates for 2021 and saying that parts of the economy recovered more quickly than it had expected after the initial blow last spring. Housing, durable goods, and vehicle sales were among the sectors that performed best, the Fed said. Not surprisingly, service sectors like restaurants and hotels continue to lag. This latest spike in cases to all-time highs puts even more pressure on those businesses and their employees.
The Fed did raise its predictions for the coming year. It now sees unemployment declining to 5% in 2021, vs. a previous prediction of 5.5%, and sees gross domestic product (GDP) coming in at 4.2%, vs. the old prediction of 4%.
You have to take those numbers with a huge dose of salt, however. One reason is because the unemployment rate doesn’t include millions of people who left the workforce due to Covid-19 and now aren’t seeking new jobs. Their absence from the job market could make economic growth harder to come by even if unemployment drops, because they obviously won’t have much spending power. And when you look at GDP, 4.2% may sound good, but it’s coming off a big projected decline in 2020. As Powell said, the economy still hasn’t gotten back to where it was a year ago, and there may be a long way to go.
The Atlanta Fed’s GDP Now meter predicts economic growth of 10.4% in Q4 2020, but many economists think Q1 GDP could be soft thanks to the latest round of economic shutdowns. If that’s the case, a major rebound would be needed in the following quarters for the economy to grow as much as the Fed forecasts over the full year. We shall see.
None of this bodes especially well for the earnings outlook in 2021, but analysts do ultimately see growth popping back after a historically awful 2020.
Research firm FactSet predicts overall calendar year 2020 earnings per share to fall a steep 13.6%. If that’s even close, it would be among the worst years on record, and the second year in a row of falling earnings for big companies.
Analysts see a big rebound in 2021 calendar year earnings, with research firm CFRA projecting 20.3% earnings per share growth for companies in the S&P 500. That could be the key number to track in coming months.
Ultimately, earnings drive the market. But heightened growth expectations can be a double-edged sword. Case in point: Some businesses that remained open during Q2 lockdowns—and turned in amazing earnings in Q3—had a hard time meeting outsize expectations. This may continue to be a trend.
Reopening Versus Stay-at-Home Stocks
If there was one theme that really dominated Wall Street in 2020, it was the battle of stay at home vs. going out. Stocks like Peloton (PTON), Amazon AMZN +3.5%
(AMZN), Apple AAPL +3.6%
DocuSign DOCU -6.4%
(DOCU), Netflix NFLX +1%
(NFLX), and Zoom (ZM) went parabolic as it became clear billions of people would be stuck at home and demanding their products like no one had predicted. This had a ripple effect on Tech, with semiconductor and cloud computing companies gearing up for skyrocketing demand as hundreds of millions of former office workers found themselves sitting on the couch with their laptops and cats.
We all know the other side of that trade. The stocks that benefit from travel and going out, like airlines, casinos, hotels, and restaurants, got slammed. Financials and Energy took it on the chin, too, as a depressed world economy reduced demand for their services and banks had to build huge reserves against possible defaulting loans.
Already, you can see some of that trade unwinding, and the question is what happens in 2021? Do the ZMs of the world go into hibernation once everyone comes back to the cubicle? Probably not.
First of all, the next six months appear to promise more shutdowns even as vaccinations begin. If shutdowns get pushed to next spring or summer, it means more of a commitment dollar-wise for companies that have already committed to providing stay-at-home work technology for their employees. Also, the third or fourth wave of adopters are likely to come in, meaning companies and individuals who’d put off doing things the new way will probably decide they can’t wait any longer.
If shutdowns last, it’s bad for most people, but good for some Tech companies. They might see benefit from holdouts who thought they wouldn’t have to spend on Tech solutions that allow people to work from home. These holdouts can sometimes be the harder sale, but can be most sticky over time. They tend to hate change, but when they finally do make transitions they stick with them, which can become an amazing opportunity for companies that offer solutions.
Once people transition to working at home more, we’re not going to necessarily see a 180. Many analysts and executives have been talking about the benefits of having more people away from the office. Basically, the pandemic accelerated a lot of technologies that may have been a few years away, but now could be here to stay.
That said, it’s unlikely we’ll see these companies follow up in 2021 with more triple-digit gains in the market. A lot of their demand has been pulled forward, and now they have to find a way to monetize it and manage it. For some of these firms, that might be a big challenge requiring management changes and consolidation. A bit of that is already happening, as we saw recently with Salesforce CRM -0.5%
(CRM) buying Slack (WORK).
Meanwhile, airlines and cruise stocks aren’t really showing a lot of life even now. That’s partly due to the soft economy, and also because this third spike in virus cases put the kibosh on outings and travel for so many. If analysts are right, the economy’s reopening will unleash animal spirits as people flock back to their favorite old vacation haunts. But it could be a long wait for anyone expecting a major comeback in the travel and leisure sector.
Banks, on the other hand, look like they’re coming out of this in very good shape. Powell said in mid-December that financial institutions remain strong and capital has held up well. Though non-financial companies tend to be highly leveraged, low interest rates allow them to handle their debt loads, Powell added. Defaults have been on the decline.
All this could support some analysts’ beliefs that the big financial companies may be able to take less protection from possible non-performing loans, helping their profitability in Q4 and beyond. That remains to be seen, but Financials are up nearly 16% over the last three months, outpacing all but one other sector (Energy) over that time period.
Finally, an area that’s relatively easy to predict. Normally going into a new year, the rate picture is one of the wild cards. That’s not true for 2021, and possibly for 2022 as well. The Fed’s latest outlook showed just one member of the Federal Open Market Committee (FOMC) predicting a rate hike as early as 2022, and just five predicting any by 2023. With rates so low, the Fed could continue to be a “backstop” for the market, causing more of the “buy the dip” scenario seen so often in 2020.
However, low rates can be tough on the Financial sector. Some analysts see 10-year yields rising from their current levels near 0.9% to 1.2% or 1.3% over the course of 2021 as the economy improves, but the Fed’s continued bond purchases could keep the lid on yields in general. The Fed has also said it could shift to buying longer-term bonds if the economic crisis continues, which would potentially hurt banks.
The low rates probably helped accelerate the recent rally in stocks to new highs. The S&P 500 Index (SPX) recently had a price-to-earnings (P/E) of 22, compared to the historic average of down near 15. But many analysts will tell you this is justified by low interest rates causing a “TINA” mentality for stocks, meaning “There Is No Alternative.”
Actually, there are many alternatives for long-term investors, and few on the Street think it’s time to “go all in” with the SPX now flirting with levels many analysts said it wouldn’t approach until the end of 2021. Still, it’s been tough for fixed income investors over the last six months as the U.S. 10-year yield basically doubled from its historic lows and the spread between high and low-grade corporate bond yields narrowed.
One alternative that’s already gaining steam is commodities. Copper and crude have been pushing steadily higher, with copper recently reaching nearly eight-year highs. This partly reflects a soft dollar caused by the Fed’s dovish policies, but also might suggest rising industrial demand as China’s economy recovers. The soft dollar might also be a boon for overseas economies and stock markets over the coming year, some analysts say.
Anyone who bets on a reopening economy might want to closely follow those commodity barometers. Rising materials and energy prices certainly could help the Energy and Materials sectors of the stock market, while any return to U.S. infrastructure spending would probably support those sectors as well as Industrials.
Washington and the Political Landscape
Speaking of infrastructure, that’s one area the new administration appears to be interested in, and it’s drawn bipartisan support in the past. We’ll see if the current spirit of cooperation on the Hill can continue beyond January 20. The Georgia Senate election on January 5 could determine that, but even if Democrats gain control of the Senate they won’t be powerful enough to get things done on their own.
Some investors might welcome continued paralysis in D.C. with a Democratic administration in place. One thing many had feared was a so-called “Blue Wave” that had a chance to bring heavier regulation on corporations and higher taxes on investments. The stock market has jumped double-digits since the election, so many investors apparently cheer the notion of gridlock.
The first year of an administration is when the new president tends to make the biggest policy proposals. Think health care with President Obama and tax cuts with President Trump. Obviously, President-elect Biden’s first major goal is to address the pandemic. After that, it’s up in the air. Maybe he’ll try to jumpstart the economy with an infrastructure package. It seems doubtful he’d try to raise taxes with the economy in a hole, but more environmental regulations—many of which he can enact with the stroke of a pen—seem pretty certain. That could end up being tough on some sectors like Energy and Industrials.
Another area the president has a lot of power over is trade. The Trump administration’s long trade battle with China may be almost over, but Biden has said he plans to initially keep some of the Trump tariffs on that huge trading partner. It’s also likely Biden could put the U.S. back into some of the global trade organizations like the Trans-Pacific Partnership (TPP). Doing this could have political repercussions, however. The steel industry has already warned Biden not to do this.
Every year has its major themes, narratives, and market drivers, and 2021 should be no exception. But after a year like 2020, we could use a dose of certainty and normalcy along with those vaccines.