Stocks are on track to close out 2020 with double-digit gains as traders shook off this year’s COVID-19 outbreak and economic turmoil.
As Wall Street strategists look ahead to 2021, the vast majority believe stocks are heading even higher. But that outcome is anything but guaranteed.
Few, if any, strategists a year ago counted a pandemic among their lists of risks to the outlook in 2020. But given what is known right now about COVID-19 vaccines, trajectory of the economic recovery and political landscape, analysts have offered their preliminary lists of some of the risks investors may face in 2021. These, if realized, may temper the bullishness abounding among investors heading into the new year.
Risk No. 1: Vaccine rollout hiccups
Virtually all of the strategists who have offered an outlook for the S&P 500 for next year cited widespread vaccine distribution as a key assumption underpinning their calls.
“The degree to which the vaccine just approved in the past few days (as well as others pending approval) is successfully distributed and accepted by the public to stem the virus is in our view the most important assumption… in achieving our price target,” Oppenheimer strategist John Stoltzfus said in a note on Dec. 14. His 2021 price target of 4,300 assumes additional upside of 16.4% from the S&P 500’s closing level on Monday, Dec. 21.
Vaccine optimism has already been a key driver of stocks’ gains over the past month, as investors priced in the lasting economic recovery an inoculation would confer. The S&P 500 has jumped more than 5% from its closing level on the session before Nov. 9, the day that Pfizer (PFE) and its partner BioNTech (BNTX) first announced their much stronger-than-expected efficacy data for their COVID-19 vaccine.
However, this has also left equities vulnerable to a downside hit. Stocks may unwind some of their recent gains if a rollout hits meaningful roadblocks, such as if vaccine manufacturers hit production delays, issues emerge in attempting to transport large batches of the vaccines at ultra-cold temperatures, or a long lapse occurs before all Americans received the vaccinations. As of Monday, the U.S. government had an agreement with Pfizer for the pharmaceutical company to deliver 100 million of its authorized COVID-19 vaccines by March and with Moderna (MRNA) to deliver 200 million COVID-19 vaccines, assuming its inoculation receives emergency use authorization as expected.
“Vaccine execution risk, delayed fiscal stimulus and longer lockdowns are risks,” Bank of America equity strategist Savita Subramanian said in a recent note. She set a price target of 3,800 for the S&P 500 for year-end 2021. “A simple move in the equity risk premium back to the prior decade average of ~500-550bps (vs. current 437bps), would drop the S&P 500 down to 3000-3050.”
Goldman Sachs economists led by Jan Hatzius said in a note Monday that they expect “large shares of DM [developed market] populations to be vaccinated by midyear,” and that most large emerging markets would reach 50% vaccination by the second half of 2021. Many public health officials and other strategists have shared similar predictions.
“We find that DM timelines are quite resilient to broad-based production misses but more vulnerable to demand setbacks,” Hatzius added. “In contrast, EMs [emerging markets] are more vulnerable to production misses and especially distribution bottlenecks.”
Risk No. 2: The outcome of the Georgia Senate runoffs
Most strategists also based their 2021 outlooks assuming that Republicans will ultimately win both of Georgia’s two Senate runoff elections in January.
Given the 48-50 Democratic-Republican split in the Senate currently, this would leave Republicans in control of the chamber to serve as a likely obstruction to any “market negative” new tax policies President-elect Joe Biden and the Democratic House of Representatives may try to advance.
Early voting just began on Monday, but these special elections won’t be over until January 5. While considered the less likely outcome at the moment, Democratic lawmakers could still take control of one or both seats, upending the divided government outcome mosts strategists have baked into their equity forecasts.
“The unexpected loss of both Republican seats could result in a ‘light blue sweep’ outcome, which could pose some downside for equities and reintroduce risk of anti-growth policy changes (i.e. tax increases),” JPMorgan strategist Dubravko Lakos-Bujas said in a recent note. He initiated a price target of 4,400 on the S&P 500. “However, we expect this risk to be most manageable given Congress has pivoted to the center (i.e. [Democratic] House majority has narrowed significantly, providing less room for drastic changes).”
Others struck a more dire tone on the stakes at play in Washington for equities, especially around the implications for corporate taxes and profits.
Under a united government, the Biden administration “could substantially raise taxes on many U.S. corporations that have benefited from lower tax rates, which have in turn improved U.S. corporate competitiveness globally, increased profitability, encouraged innovation, strengthened balance sheets and contributed to job growth (prior to the economic shuttering necessitated by the pandemic),” Oppenheimer’s Stoltzfus said.
Risk No. 3: ‘Liquidity tapering’ and firming rates
Ultra-low rates in 2020 helped support virus-hit companies by keeping borrowing costs low, and investors piling into stocks amid a hunt for yield.
Over the medium- to longer-term, the Federal Reserve’s and other central banks’ highly accommodative monetary policy strategies may produce some give-back for equities as they begin to unwind some of their crisis-era policies, argued JPMorgan’s Lakos-Bujas.
“Liquidity tapering, higher rates and [an] inflation scare are key medium/long-term risks,” he said. “Record global central bank liquidity has been key in supporting equities by facilitating credit market function and helping restore balance sheet cash across sectors. This has helped keep afloat both healthy and marginal companies, and fund new / emerging companies.”
To be sure, the Federal Reserve has recently signaled that interest rates would likely remain near-zero through at least 2023, and that its current, aggressive rate of asset purchases would continue until “substantial further progress” has been made in the post-virus economic recovery. But the Fed’s longer-term path forward for monetary policy – and any signals of tweaks to come that may emerge next year – will be something to watch for investors.
“When the Fed signals some tapering, we would see it as a risk-off event triggering some de-rating in multiples,” he said.
Meanwhile, although many analysts expect inflation to remain relatively subdued through next year, Lakos-Bujas made the case for 2021 to lay the groundwork for the start of an eventual trend higher.
“The market expects some firming of the cyclical component of inflation concurrent with cycle expansion in 2021,” he said. “However, longer term, the risk of structural increase in trend (i.e. average) inflation may be higher than any time in the last 25 years or so.”
“The huge injection of money/QE [quantitative easing], the Fed’s expressed tolerance of higher inflation for a while and large public debt pose an inflation tail risk, and could have significant negative implications for equity valuation/multiples and many quantitative strategies that are back tested in a mostly low inflation environment,” he said.
Emily McCormick is a reporter for Yahoo Finance. Follow her on Twitter: @emily_mcck
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