2021 Market and Economic Outlook

SPX Monthly Chart:

• The market basically closed the year at ATH (3pts off) and is within a hair of 3855, which is the 138.2% Fib of the March low.
• The rising monthly channel (shown above) shows that markets are stretched near resistance and already outside of their bollinger bands. The weekly band is at 3774.
• While I believe there is room for upside into 2021, the risk/reward is NOT favorable here anymore. Sentiment is stretched and a correction would be welcomed with open arms.
• I anticipate a 10-15% correction to start the year, which would align us with the rising 200dma near 3219. We ended the year in a tight range, and there is potential to carry into 3855 based on January 15 open interest and gamma positioning.

Last few days I have been selling stocks and calls aggressively in anticipation of a correction. I am long TLT calls (flat) and SPY puts (down 37%).

Sentiment:

• The AAII Sentiment Survey is quite elevated near multi-year highs and shows overly bullish sentiment.
• The Advisors Sentiment Report reports the views of over 120 independent investment newsletters (those not affiliated with brokerage houses or mutual funds) and reports the findings as the percentage of advisors that are bullish, those bearish and those that expect a correction. The current Bull to Bear spread is one of the highest in decades, yet another indication of frothy sentiment.
• The NAAIM Exposure Index is currently at 89 and off some 100+ prints but remains elevated to the averages.
• The BAML Fund Manager Survey shows the three most crowded trades are:
  • Long Tech via shares
  • Short USD
  • Long Bitcoin Spot via Perpetual Swaps
  • Fund managers are "all-in" on leverage. This is evidenced by our DIX print on Thursday yet again showing dark pool buying.
• Consumer Confidence deteriorated sharply in December, as the resurgence of COVID-19 "remains a drag on confidence.”
• CEO Confidence, as tracked by the Bloomberg Consumer Comfort Index hit a two week low at 47. This is the sharpest drop in economic outlook since April.

Market Health:

• NYSE Cumulative Adv/Dec:
  • Actually pretty healthy right now. This is still well above all of its important moving averages and remains in an uptrend.
• NYSE McClellan Oscillator:
  • Neutral currently.
• NYSE Summation Index (NYSI):
  • Most commonly used by fund managers to find divergences. Above a short term 5/8 day exponential moving average is a buy signal. Below flashes a short term sell signal. This is currently showing a sell signal. However, sell signals in rallies tend to be early signals...
• Moving Averages:
  • The 8/21-week EMA crossover has long been a favorite signal for momentum in individual names and also works with Indices. The 21-week EMA is important support for growth/momentum stocks. In general, you want to be long when the 8 week is above the 21 week and short when it is below with crossovers being key trend inflection signals. The 12-month moving average (MA) and monthly MACD are good longer-term risk management tools. The price action relative to the 200-week MA provides a good gauge for the health of the S&P 500’s secular trend. Pullbacks or corrections (aka cyclical bear markets) for the S&P 500 that hold above or near the rising 200-week MA are a secular bull market pattern. Pullbacks that decisively break the 200-week MA are a sign of a secular bear market. Most corrections on the S&P 500 during the 1950-1966 and 1980-2000 secular bull market held between the 100-week MA and the 200-week MA. The 2015-2016 S&P 500 pullback fit this secular bull market correction pattern. The secular bear market periods from 1929-1950, 1966-1980, and 2000-2013 saw sustained periods below these long-term moving averages. This means that the 200-week MA provides a good secular bull market risk management tool or stop loss. Using this history as a guide suggests that the Ichimoku monthly cloud is a good trailing secular bull market stop loss. History also suggests that a decisive move below the monthly cloud confirms a secular bear market for US equities. Currently we are above all moving averages and this is a bullish signal.

Economics:

• The common theme appears to be an expectation of a synchronized global growth in 2021.
• The optimism on 2021 delivering a record year for corporate profit growth and strong GDP growth around the globe is very contingent on a successful vaccine rollout. The current surge of cases and hospitalizations in the US and Europe is resulting in further restrictions and lockdowns that will weigh on growth expectations, or at least push out pent-up demand. Consumers have led the recovery so far with a boost from fiscal stimulus but the key to a self-sustained recovery is a strong capex cycle which is seen kicking off in Q2 2021. The labor market will also be in focus after record low unemployment the pandemic saw the number jump to 14.7% in April, the highest since the Great Depression, but has recovered rapidly though losing some momentum as it finished the year near 6.5% unemployment and consensus expectations to reach 5% by the end of 2021, still far-off from the 3.5% pre-crisis rate.
• The recovery has already started in 2H20 in the US & China while the European recovery has been more subdued. The driver of the strong 2021 recovery will be the full reopening of economies worldwide which makes a successful vaccine distribution critical. The US Dollar is closing 2020 weak and looks to have some structural issues with surging deficits, Fed’s intention to boost inflation, easy financial conditions, and expected economic and political improvements. The combination of easy monetary policy, a rebound in old economy industries and a global upswing in growth provides a healthy backdrop for 2021. The balance sheets of households, corporate and governments are expanding alongside the aggressive monetary policy and signs of inflation returning causing a rotation back to value and cyclical growth supported by a steepening yield curve.
• GDP is seeing rising 6.4% globally in 2021 according to Morgan Stanley, the consensus is for 5.4% growth. In the US those numbers are 5.9% and 3.8% respectively.
• Inflation would be the key risk into 2021 with it likely to start showing up in 2H21, and the risk being an overshoot could start a disruptive shift in Fed policy. Surging debt remains another concern, as a share of U.S. GDP, total debt has spiked near a record high and total nonfinancial debt has surged to new all-time highs. The rapid increase in government deficits is due to the combination of 1) the budget shortfall that already existed and was growing, plus 2) the deficit spending to fund the stimulus programs to date.
• The other clear risk in 2021 is China where debt defaults are rising and could spark a move to credit tightening and a recession that would strangle the global recovery. The overall default rate is currently low but the percentage spike in debt/GDP was the highest since 2009 which could lead to policy tightening in 2021.

Market Valuation and Fundamentals:

• The NASDAQ continue to outperform in 2020 with a 45%+ YTD return compared to the S&P at +15% as major secular trends in technology continue to play out. The trend of rapid rotational moves also continue with growth often seeing selling pressure for a few days before quickly recovering and resuming the longer-term uptrends. Into 2021 earnings growth is expected to be a record though room for multiple expansion is minimal. A combination of improving economic conditions causing greater business and consumer confidence should drive strong earnings growth in 2021. Increased fiscal spending and a moderation of tariffs provide additional tailwinds. In 2020 many businesses shedded labor and transformed business models to higher productivity to offset the collapse in demand and low inventories with rebounding production point to margin expansion in 2021. The 2021 environment shapes up to be one of solid earnings growth, a return of buybacks and modest multiple contraction. The growth versus value debate is likely to continue but the low-rate environment continues to favor growth, but even more-so a greater preference for quality, companies with strong balance sheets, cash flow generation, and returns on capital should continue to outperform. We are seeing historically strong earnings revision ratios and a record percentage of stocks with dividend yields above the rate of the ten-year Treasury, both conducive to allocations to equities. Compared to bonds, equities can act as a hedge in case of inflation and, with a thorough selection process, can still offer returns closer to historical returns.
• My forecasts for 2021 take into account consensus expectations, a bull case for a strong vaccine rollout, and a bear case for disruptions to the vaccine rollout and geopolicatical potential issues. I am assigning a 40% probability for the bull case, 40% for the base case, and 20% for the bear case to arrive at a S&P fair value of 3600 though 1H21. In 2H21 we start to look to 2022 estimates and feel we can approach $200 EPS with slight multiple contraction to 22X leaving upside potential to 4400 for year-end 2021.

https://imgur.com/a/QqPjfbU

• For 2021, the bottom-up EPS estimate (which reflects an aggregation of the median EPS estimates for CY 2021 for all of the companies in the index) is $169.20. For CY 2021, analysts are projecting earnings growth of 21.7% and revenue growth of 7.7%. The 6% trend growth rate since the 1930s would point to S&P 500 EPS getting back to trend levels of $187 in 2022. An optimistic vaccine scenario would see S&P 2022 EPS well above $200.

https://imgur.com/a/lLhmsb3

• The low rate environment impacts the multiple, and assuming the 10-year stays low, the Fed keeps rates at zero, and credit spreads stay firm, a valuation framework would put a trailing PE at 24X and forward at 21.5X for the current environment. The spread between the S&P dividend yield versus the corporate Baa bond yield is near historical highs and the ERP (Equity Risk Premium) is very high by many measures. Assuming the spread between the dividend yield and IG corporate yield goes back to 2012-19 levels, it would point to 30%- plus upside for S&P 500 valuations. Assuming some rise in rates as the spread narrows more from falling equity yields would point to 20%-plus upside. In 2021, policy support should remain in place to curtail risk aversion. Besides the risk of a credit crisis, concerns over a late-cycle overheating have been pushed further out due to the pandemic-induced recession and policy makers’ increased inflation tolerance. When comparing relative attractiveness across asset classes, which ultimately steers a substantial part of investment flows, equity markets continue to look quite attractive. Since the beginning of 2020, real bond yields in the USA have declined by over 100 basis points, outpacing the decline in earnings yields (inverse of the price-earnings ratio), thus supporting higher valuation multiples. Currently the difference between the earnings yield and the real bond yield as a measure for the equity risk premium (ERP) is higher than the long-term average, suggesting that equities offer an attractive excess return over bonds. Although lower interest rates support higher multiples due to the increase value of future earnings, a return to normal could push long-term interest rates higher and exert downward pressure on equity valuation multiples.

Sector Growth Rates

Analyst 2021 Predictions:

• Morgan Stanley: $3900 - After a year of big swings in valuations, 2021 will be about who can deliver on earnings. 2020 was all about beta and understanding how equity markets trade in and around a recession that handed us the fattest pitch we’ve seen in a decade. 2021 will be much more about stock picking (alpha) and should favor those companies that can deliver earnings growth that isn’t already expected or priced. MSCO prefers companies with earnings growth most tied to re-openings and an economic recovery and also favors small caps. Financials are also preferred due to positive upside skew on rising rates and better credit; Materials and Industrials on demand rebound, earnings leverage and inflation protection; and Health Care given its GARP characteristics and re-rating potential with fading political overhangs.
• Bank of America: $3800 - Stocks have already priced in much of the expected recovery in the economy and corporate profitability, leaving just slightly more upside heading into next year. Even as investors ride a wave of vaccine-related optimism, potential negative catalysts abound. The recovery is intact and the world likely reopens in the 2H, but a lot of optimism is priced in already on vaccine/recovery. Vaccine execution risk, delayed fiscal stimulus and longer lockdowns are risks. But a few themes support stocks: the S&P 500 dividend yield is 3x the 10-year yield, and S&P 500 dividends are set to increase in 2021. And unlike bond yields, earnings are nominal and participate in inflationary upside – where inflation risks may be running higher, given rampant money-printing and a potential post-vaccine spike in demand. BAML picks value stocks over growth, cyclicals over defensives and small caps over large caps, given each of these groups’ likelihoods to be disproportionately boosted by a post-virus economic recovery.
• Goldman Sachs: $4300 - A vaccine is a more important development for the economy and markets than the prospective policies of a Biden presidency. The economic reopening coming alongside a vaccine, in tandem with a status quo policy environment cemented with a divided government, will help push the S&P 500 to 4,300 by year-end 2021 and then to 4,600 by the end of 2022. The forecast assumes that the Senate will remain under Republican control following the Georgia run-off elections in January, the economy will continue on a path toward a “V-shaped” recovery, corporate profits will rebound, Fed funds rate will hold near-zero and the yield curve will steepen while the 10-year Treasury yield climbs only modestly.
• Deutsche Bank: $3950 - Much of 2020’s run-up in the stock market came with multiples expansion, as prices escalated despite a drop in earnings, as companies dealt with fallout due to the coronavirus pandemic. Next year, as the economy recovers and a vaccine allows for long-lasting re-openings, earnings growth will rebound and multiples will de-rate. The pattern of the equity market recovery, bottoming halfway through recession and recouping most of its losses before it’s over, has been typical but the continued run-up means valuations are high. In our reading, elevated multiples reflect increased participation of retail investors which we see as sustaining, but we expect the multiple to begin to de-rate. For 2021, a recovery in earnings — which essentially increases the denominator of the price-earnings ratio — should lower multiples. That said, an increase in companies’ payout ratios as dividends and buybacks return could at least partially offset this. A gradual correction of overvaluation argues for the current overvaluation of 5 multiple points to diminish but remain significant at 3.6 points, putting the end-2021 multiple at 20.5X.
• Jefferies: $4200 - Improving prospects for a vaccine, easy lending conditions and broader participation among cyclical and value stocks will help propel the stock market higher in 2021. November’s historic stock market rally, led by cyclical and value stocks in the energy, financials and industrials sectors, reflected broadening equity strength beyond just big tech and software shares. That rotation is anticipated to continue into next year, helping push the broader market higher. Notwithstanding the second and third Covid-19 waves permeating the world, there is a palpable feeling that the global economy is resynchronizing with the household, corporate and government balance sheets expanding simultaneously alongside aggressive monetary policy. The much-maligned value and cyclical growth sectors are slowly making a comeback as inflation pressures begin to return. This rotation has been supported by a steepening in the yield curve and with growthier stocks trading sideways. Improved visibility towards a successful coronavirus vaccine, easier lending conditions, little evidence of deflation and a sentiment switch from growth to value will lift US bank shares through 2021. Rising global capacity utilization rates, firmer producer prices, improving world trade volume, booming housing/autos and a weak dollar are the perfect environment for the S&P 500 Industrials. The S&P 500 materials sector is blowing off in response to a weak dollar, higher commodity prices, an upswing in global manufacturing and a restocking cycle.
• CSFB: $4050 - Our 2021 forecasts are designed to answer a simple question: what the future will (2022) look like in the future (end of 2021). From this perspective, we are forced to de-emphasize the near-term, focusing instead on the return to a more normal world. As we look toward 2022, the virus will be a fading memory, the economy robust, but decelerating, the yield curve steeper and volatility lower, and the rotation into cyclicals largely behind us. Since the stock market discounts future events, each of these prospects for further improvement down the line should translate into a higher S&P 500 as investors price in these events.
• UBS: $4100 - The vaccine-related developments that drove stocks’ gains in November and early December have now been baked into market expectations, leaving vaccine distribution the next milestone for equity investors to consider in 2021. The key driver of U.S. equities will be the pace of vaccinations, similar to how shifts in mobility drove equities through the spring and summer. As people get vaccinated, they are likely to ‘normalize’ spending on areas impacted by COVID shortly thereafter. We see the rotation toward cyclical services spending and other COVID-hit areas as a key investment theme for 2021. UBS is overweight the consumer discretionary, industrials and energy sectors given that consumption and production will likely rebound next year. It downgraded materials and financials to Neutral. It is also Underweight consumer staples, utilities and REITs and Neutral on information technology, but overweight communication services and health care on still attractive growth relative to valuations. UBS maintained an upside case for the S&P 500 of 4,400, which would emerge in the case of higher-than-baseline growth against a backdrop of still-low interest rates. However, in a downside case, the S&P 500 could fall to 3,300, which would entail a weaker recovery and/or tighter financial conditions.
• BMO Capital: $4200 - Heading into 2021, stocks are poised to keep reaping the benefits of the massive infusion of monetary support from the Federal Reserve, along with an anticipated additional round of fiscal stimulus. This constructive policy environment is likely to help push equities higher even as virus concerns linger for at least the first several months of the new year. Even with recent positive vaccine and treatment developments, the global pandemic and its unprecedented impact is unlikely to fade in coming months. As such, the massive fiscal and monetary response in the U.S. and around the world (also unprecedented) will likely remain in place to combat its negative economic impact for the foreseeable future. Such environments have historically supported continued stock market gains and we see no reason why 2021 will be any different. Aside from the global financial crisis, 2020 represented the swiftest quarter-over-quarter earnings collapse for the S&P 500 where index EPS plummeted nearly 50% during 1Q, thus, we anticipate that 2021 has the potential to be one of the best years ever in terms of earnings growth, something we believe will also help to push stock prices higher. We remain optimistic and expect another year of double-digit gains as the economy and society slowly transition back to normal.
• Barclays: $4000 - Markets are right to be optimistic about the global economic outlook in 2021, with growth returning and inflation rising but staying below central bank targets. Projected global gross domestic product growth of 5.6% in 2021, rebounding from a 3.6% contraction this year, with most Western economies reaching so-called herd immunity from Covid-19 in the second and third quarters of the year. Forecasts reflected the recent slew of positive vaccine results with efficacy rates exceeding expectations, which point to a significant boost for growth in the second quarter of 2021. Barclays also suggested the inflation outlook would not indicate any unwinding of current unprecedented levels of central bank support. Labor markets are recovering, but we are still at very high unemployment, so there is undeniably a lot of slack in the system. That means that when it comes to core inflation and the underlying drivers, to wage costs etc., that was unlikely to happen in the short run, meaning even next year. It would take several years really to come back. While Barclays anticipates a gradual improvement in inflation, it will not be significant enough to cause central banks to consider tightening their accommodative monetary policy stances. We have an environment whereby growth comes back, inflation stays relatively muted, and you have central banks continuing to support the recovery, and tightening is still far out.
• Oppenheimer: $4300 - The S&P 500 is likely to post another double-digit percentage gain in 2021 as the distribution of COVID-19 vaccines underpins a lasting economic recovery. This outcome is based on six key assumptions: First, that the public will expediently accept and receive COVID-19 vaccines and second, that equity investors will discount the success of the vaccines in reversing the disruptions brought on by the pandemic. Thirdly assumes that at least one of the two Senate seats in the Georgia runoff election will go to a Republican lawmaker, thereby retaining their control of the Senate and reducing (if not necessarily eliminating) the risk that the Biden administration will eradicate the corporate tax reform act of 2017. Fourth, the Federal Reserve will continue its low interest rate regime in tandem with accommodative monetary policy, and fifthly, that congressional lawmakers will step in with another round of fiscal stimulus by the first quarter of 2021 at the latest. Lastly, that investor appetite will continue to tilt toward “stocks that favor diversification and both growth and value segments of the market in a relatively low interest rate environment that favors equities, real assets and other asset classes over fixed income for intermediate and longer-term objectives. The vaccine rollout is arguably the most important in determining the trajectory of the S&P 500 next year. Ultimately the stock market is broadly dependent on economic growth to drive revenues and earnings across the sectors.
• JP Morgan: $4400 - Investors are entering 2021 against a confluence of market-positive events, including improving prospects for widespread vaccinations and sustained economic reopening, gridlock in Washington and accommodative central bank policy. Given the COVID-19 crisis, vaccine distribution is likely the linchpin event. But even with widespread vaccine availability still months away, optimism over early vaccine efficacy data has already sparked a rally among stocks hardest-hit by the pandemic. The equity market is facing one of the best backdrops for sustained gains in years. After a prolonged period of elevated risks (global trade war, COVID-19 pandemic, U.S. election uncertainty, etc.), the outlook is significantly clearing with the business cycle expanding and risks diminishing. We expect a ‘market nirvana’ scenario for equities with the melt-up continuing into 1H21, driven by earnings recovery and multiple expansion. Much of next year’s stock market rise is likely to come at the beginning of the year, as lingering uncertainties over vaccine distribution, the results of the Georgia senate race and additional monetary and fiscal stimulus start to dissipate. While the broader backdrop should still remain constructive in the second half of next year, by then the market will have likely priced in close to a full recovery and investors may start to expect a gradual shift in central bank forward guidance away from the current exceptionally accommodative stance.
• BTIG - $4000 - Global synchronized growth underpinned by central bank ease and a Washington which sees Election 2020’s decidedly mixed outcomes as a catalyst for cooperation (spend, it’s necessary) and centrist government (no tax hikes) results in a Redistribution of Wealth consistent with the 2003-06 synchronized reflation period where Value outperformed. Growth, Small Cap outperformed Large Cap, and International equities outperformed the S&P 500.

Gold:

• Monthly
• Gold had a solid year in 2020 gaining more than 20% as a long base breakout that triggered in June 2019 continued to play out higher and reached its measured move objective while the rally briefly broke above 2011 highs before pulling back. If we look at Fibonacci extension targets of the 2011-2015 correction GLD has upside targets at $207 and $220. The 2018-2020 rally has Fibonacci retracement support levels at $162.5 and $152.5. Gold rallied in 2020 on economic uncertainty and a flight to safety and has pulled back in Q4 with the greater optimism for 2021 taking hold. On an allocation basis, Gold may be losing some of its luster as a store of value with the momentum seen in Bitcoin , although that has not been seen to this point with global gold ETF inflows topping a record in 2020 as a way to diversify portfolios and hedge against inflation. However, November saw the second largest outflow on record. In 2020 the lockdowns resulted in a 5% decline in global output, so the supply-side is expected to rebound in 2021. Gold prices should be supported by inflationary pressures, a deep fiscal deficit and a weaker USD. Goldman sees Gold reaching $2300 in 2021 as recovery from the coronavirus-related recession fuels higher inflation next year. Further fuel could be added from a recovery in demand from India and China.