Brief Thoughts on 2021

The new buzz in the year-end prediction drill for advisors is to “not predict” which is one way to stand out from the crowd.

The other well-worn stat is that we typically see many predictions for the SP 500 for the next calendar year magically land between the +8% to +13% range, which per one statistic read years ago and I can’t recall the source, noted that of the last 100 years of SP 500 returns, 80% of the return distribution for the SP 500 lands between +8% – +13%, so, if you want to make a prediction and look smart, that’s the bet.

Equity allocations:

A 2021 expectation of 8% to 13% probably isn’t out-of-line (sorry). In 2019 and 2020, the SP 500 returned 31.8% and 17% (with another 6 hours left in the final trading day of 2020), for a combined 48.8% in the last two years, or an average of 24.4% per year, and if 2018’s SP 500 return of -4.5% is included, an average of 14% over 3 years. In other words, the last 3 years even with the negative year in 2018 results in a “slightly above-average” return. The fiscal and monetary stimulus still bode well for a solid 2021 for the stock market, while the prospects for the January 5th, 2021, Georgia Senate races giving the Democrat’s a “Blue Wave” will likely lead to higher taxes in 2021, either corporate income tax rates and / or higher capital gains tax rates. Divided government is not a bad thing.

Statistically, it’s easy to assume the SP 500 has a “below-average” year in 2021. (And that’s just a guess. Take any prediction or forecast with a substantial grain of salt.)

The non-consensus expectation for 2021 (or at least it was non-consensus up until a few weeks ago), is that Emerging Markets and Non-US will do substantially better than the SP 500 next year. The weaker dollar is one catalyst, and the buck is plumbing multi-year lows the last few weeks, and the sudden outperformance of the Basic Materials, commodities and Energy groups reminds me so much of 2000 to 2006, after the collapse of Tech and large-cap growth.

In March, 2000, with that historic peak in the Nasdaq over 5,000, all the sectors and asset-classes that hadn’t done well for the prior 2 – 3 years, like small-caps, like Non-US, like commodities just took off and really didn’t stop until 2007. The Nasdaq peak and the subsequent out-of-favor rally in long dormant deep-value sectors was a seminal moment in early 2000.

Today is very reminiscent of that, just on a much less smaller scale. Here is an article written in July ’20 where I talk about the “March, 2000 moment” and then followed it up with this article in mid-July ’20 talking about a less-severe form of rotation on it’s way.

In fact the September 2nd peak for the SP 500’s largest tech components and subsequent outperformance of the Russell 2000, Emerging Markets, Non-US, and commodities was similar to 2000, but smaller and less dramatic. Valuation is one reason – as one article updated last night shows – the Big 5 Tech names are expensive on a valuation basis, and P/E’s could compress for the sector, but as Ed Yardeni showed over on his blog this year, Tech sector earnings in March 2000, were roughly 13% – 15% of the SP 500 when the market cap weight peaked at 33% in March, 2000, while today, with Tech’s market-cap weight around 25% – 27% of the SP 500, the earnings weight of the sector is in the low 20% range, so “earnings weight as a percent of market-cap weight” is much better “relatively” today than in March, 2000.

2021 could simply be a year where everything that didn’t work in 2020 on the equity side, starts to outperform. That’s as complex as it gets for me.

Bond / Fixed-income: 

All of client’s investment-grade and mortgage exposure has been sold given it’s lack of relative value. Credit risk and high yield still look better relatively but that window could shrink quickly as we push through 2021. The high-yield credit market was bifurcated this year between what was working, while cyclicals like airlines, cruise lines, energy and commodities and anything that was crushed or lagged on the equity side, saw credit spreads stay very wide. Presumably, with the rebound starting on the equity side, that “bifurcation” will start to reverse.  Mall CMBS had a tough year and will likely continue to be stressed.

While absolute yields are the lowest in history, even in high-yield credit, primarily thanks to a 93 basis point yield on the 10-year Treasury, “relative” credit spreads are still above the 2006 – 2007 high-yield “tights”.

It is getting much more tempting to reach for yield in fixed-income, but be careful. I think the bond and credit markets have far less value – both absolute and relatively – than  the equity market today. Some bond funds have even allocated a portion of their portfolios to individual stocks with stable dividend yields, which makes sense, but I can’t tell clients that “this is a bond fund” when the 80% – 85% fixed-income allocation is just that and rest is equities.

Given Jay Powell’s very dovish interest-rate commentary at the mid-December ’20 Fed meeting, I’m surprised the 10-year Treasury yield didn’t rally at all and in fact traded back close to 1%.

Summary / conclusion: If 2021 sees the SP 500 lag some long out-of-favor asset classes like EM and non-US and small-cap or SP 500 “equal-weight” RSP, don’t be surprised. However, Tom Lee, Fundstrat’s CIO thinks the SP 500 could end 2021 at 4,300 which would be a 15% return for the key benchmark for 2021. Tom’s work is very good.

When this post was written in November ’20 talking about this secular bull market’s long-tern returns, a reader could probably (and safely) conclude that the current bull market in the SP 500 is probably 60% – 65% through it’s secular bull. Secular bull markets typically last 15 –  20 years. However no one tells you when they end.

Take everything here with substantial skepticism. I am nervous headed into 2021 and that’s probably a good (contrarian) sign for the bulls. The “expected” 2021 SP 500 EPS estimate, which will be updated this weekend, is currently around $167 per share, which is just $5 higher than the actual 2019 SP 500 EPS of $162.93 or 2.5% greater despite the fact that the last two years, the SP 500 is up a cumulative 48.8%.

Forecasts and predictions can be quickly rendered worthless as 2020 demonstrated.

May readers have a safe and enjoyable New Year’s Eve and New Year.

More to come this weekend.

Thanks for reading.

 

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