The challenge of predicting the future is you have to wait to find out if you’re right.
As much as folks may want to claim they can predict the future – especially around the stock markets – the reality is, you can’t; because investors are fickle, and supply and demand are funny things.
Underneath all the layers of sophistication – the models – the math – the rationalization – are humans and machines. These market participants are crunching all this data, trying to get to one basic decision: should I own this investment or not? Buy, hold, or sell?
It’s a simple explanation for how markets can get irrational – because people can get irrational.
So looking into the future, after 2020 gave us so many new variables to consider — so many things that can shift both the supply and demand side of the equation — is really more of a glorified guess than much else.
Yet here we are, doing our glorified guessing.
So, what concerns are on the table?
Biggies: a mess of a political climate; monetary policy and the repercussions of creating new dollars; fiscal policy and the creation of new taxes or legislation; foreign policy and geopolitical risk; environmental policy and its impact on regulation; the list goes on.
So how do we make sense of it all?
Here’s an old adage that’s appeared on this blog: keep doing what you’re doing until the markets tell you to change. It’s a rather simple way of saying ‘don’t fight the trend.’
So, until the trend shows evidence of changing, what then?
Short-term (as in, for the next week or two… or maybe longer), the markets are declining in volatility and moving higher. Largely this appears to be in anticipation of additional government stimulus. The PPP program has a second wave, and it appears likely there will be more direct stimulus (essentially beta testing universal basic income – a subject for another day).
The push higher, in the short-term, has followed a trend line the past several weeks evident in the graph below. If trend continues, expect the SPX to finish the week somewhere between 3827 and 3851.
Looking a little deeper under the hood, the chart below shows the S&P 500 as over-bought. As discussed in the past, this is a condition, but not necessarily a short-term indicator of a pull-back in prices.
The temptation is to assume markets want to pull back, or revert to the mean. Longer-term, this may be the case. But often times markets will find a sort of short-term consensus that leads to a push higher for prices. When this happens, you can see markets in over-bought conditions for a while. In fact, sometimes markets even break-out higher. So don’t read too much into this. It just means the up-trend is currently in place. Once it breaks, we likely see a spike in volatility and downward moves in prices. Until then, we look for confirming indicators and other signals to help validate where the herd is headed.
Finally, looking ahead to the rest of 2021…
This is a very challenging year to project. Based on the current Price-to-Earnings multiple and projected earnings, the S&P 500 projects out to 5200. That’s a gain of about 40 percent.
Frankly, this seems extraordinarily unlikely given the overall economic uncertainty of the day.
Taking a more subdued view of the future, we have a year-end target for the S&P 500 between 4260 and 4350.
There is some math behind these numbers, and a lot of trend analysis. If you’d like a deeper dive into this, watch last week’s forum call under the technical section at about 35 or 40 minutes into the call.
The summary is this: if you sort of normalize data and take some of the Covid extremes out of the mix, the trend was still pretty strong. That trend should continue in the near-term because of additional stimulus. But, with the political regime change and the blue wave in Washington, it’s more likely we see a return of Obama-era policy and additional regulations. This should create some growth headwinds for earnings, which in turn will slow down the rate of growth.
If these projections are correct, the first quarter of 2021 should be relatively strong, but it’s likely the markets will have to digest some policy change – and possible inflation – that will likely derail the current up-trend. Hence the low probability of a 5200 finish for the SPX.
Another trend to watch for 2021 is asset rotation. Large tech has been a huge beneficiary of the Covid trend. This sector of the market has driven a large part of the major index returns.
If money begins to shift from less large-tech over-weight into other sectors of the markets, the major indexes could experience some headwinds. However, other areas of the market – such as small and mid-caps, value players, and international holdings — may benefit from asset rotation.
So these are major themes we’re watching this year:
Will the Fed begin to increase rates in the latter half of the year in response to rising inflation? Will a big-tech asset rotation create opportunities in other areas of the market? Will emerging markets benefit from a weakening dollar as rates rise? Will commercial real estate recover after covid, or has the workplace permanently changed to a more work-at-home model?
Oh, and don’t worry. There will be more questions. We’re only a week into 2021 and look what we’ve already dealt with. And you thought 2020 was an adventure…
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