Monthly Outlook: January 2021
Like everyone else, we’re ready to say goodbye to 2020, although it was a decent year for investors. Our managed portfolios made nice returns. But overall, I think I’ve aged more than one year this year from all the stress of COVID, politics, and economic restrictions. We’re all ready to return to normal, but it won’t happen on January 1st. Surely, we’ll muddle our way back towards normal, but we’ll have hiccups and challenges along the way.
As we look ahead to 2021, it’s tempting to join the hordes of pundits who make their Year Ahead Predictions for the markets. It seems that every money manager has a Top 10 list of predictions that skew optimistic and sure-fire. We love to read them because we want to believe! Plus, optimism and confidence sell subscriptions and products. Unfortunately, history proves that most of these predictions will be wrong and frankly, worthless. As Yogi Berra said, “It’s tough to make predictions, especially about the future.” So, for that reason, we’ll spare you any predictions and a know-it-all attitude. That said, it is reasonable to share some possible scenarios that could influence markets for better or worse, just so we’re prepared if they do happen. Remember, our iFolios strategy doesn’t require us to predict at all, it just requires us to allocate more money to markets that are trending higher and to reduce exposure to down-trending markets.
Markets Starting Positions
As we start 2021, let’s look at where markets are today. Stocks have climbed back to all-time highs and are trading at the most expensive valuation levels in the last 100 years, higher than other peaks including 2007, 2000, and 1929. Investor confidence readings are at all-time highs and cash levels in portfolios are at all-time lows. Margin debt is at all-time highs, too, so not only is everyone “in,” but they’re also using leverage to be “more than in.” We know that the Federal Reserve and the Congress have provided trillions of dollars in stimulus of various types, and this easy money policy has inflated financial assets including stocks and high-end housing. We know that Wall Street analysts are expecting S&P500 earnings to recover from $93/share in 2020 to $144/share in 2021. That’s a huge 55% earnings growth rate and reflects an overly optimistic view of the economic recovery post-COVID. Lastly, interest rates remain at all-time lows (the 10-year US Treasury rate is just 0.93%) partly as a reflection of the current economic recession but mostly due to Federal Reserve bond buying manipulation. So, a lot of great expectations are priced into stocks as we start 2021. What could go wrong? What should we be watching for?
Possible Scenarios for 2021
On a positive note, the current divisive political environment could become more moderate and bipartisan in 2021, leading to reasonable policies and more stability for the economy and markets. Coronavirus could dissipate as the vaccines take effect, enabling the economy to gradually reopen. Once Brexit is behind us this week, it’s possible the European Union forms trade agreements with the U.K. that allows for more stability throughout Europe. These positive scenarios are mostly priced into the markets and are driving the current market uptrends. Under these scenarios, we’ll want to stay fully invested and continue to make money. That’s our base case. It’s negative surprises that we must be ready for as they would turn stock markets to downtrends and require us to sell.
So, what negative surprises could develop? It’s possible that the vaccines won’t work as well as we hope or could take longer to get distributed. We’ll watch the still-high 7% unemployment rate for any resurgence higher as the economy takes longer to reopen. Trade wars with China could escalate as countries try to protect their own economies. Tax policies could become more punitive as politicians focus on wealth inequality. We’re keeping an eye on interest rates, too, and hoping that an economic recovery won’t lead to higher interest rates and mortgage rates, a negative for property values. There’s a good chance that Value stocks start to outperform Growth stocks and International stocks could finally outperform US stocks. These negative scenarios would likely require us to reposition our managed portfolios. We’re ready either way, without any need for predictions.