Why 2021 could be bumpy for investors

It's not just the number of coronavirus infections in the US that are rising inexorably, the country's leading stock indices are also continuing to shake off the pandemic. In recent weeks, the optimism that took hold over the efficacy of COVID vaccines has turned into euphoria.

Even the likely long-term economic effects of the health crisis have been largely priced in by investors. The rising expectation that things will soon return to normal is driving the market, analysts say.

"The major vaccine breakthroughs in November and December have reduced uncertainty," wrote Janet Henry, chief economist at HSBC bank, in her equity outlook. As a result, she says, more and more investors are positioning themselves now to take advantage of an anticipated economic recovery. The fear of missing out on favorable entry prices is steering their behavior.

Major fund managers and investment houses are also optimistic about the coming year. Investment banks Piper Sandler, Oppenheimer and JPMorgan are predicting a significant upswing for the S&P 500, America's largest benchmark index.

In the next 12 months, it could make a strong leap above the 4,000-point mark, which would represent a gain of about 18% from today. Huge fiscal stimulus, further central bank injections and the likely economic rebound are all cited by analysts as price drivers.

However, the resurgence is not likely to happen without headwinds, they add. The vaccine headlines are positive for now, but the pandemic and its unprecedented economic effects will not disappear overnight.

Investing and the US election

For his part, Tobias Levkovich, chief investment strategist at Citigroup, believes the economy faces a significant period of weakness in the face of renewed lockdowns. "Vaccines may be lighting the way to normalization, but for now a harsh winter looms," he wrote in his 2021 outlook.

Uncertainty persists too over the legislative power of the next US administration. Investors are waiting with bated breath for January 6, 2021, the day that Congress will officially announce the winner of the presidential election. But it remains to be seen which party will control the Senate and thus the legislature. Two runoff elections in Georgia are expected to decide the race in early January.

Markets are currently positioning for the Republicans to maintain their Senate majority, which would significantly weaken Joe Biden's progressive reform agenda. Wall Street "would like to see the Republicans keep at least one of those seats [and therefore a majority] because that stops a lot of taxes from going up and a lot of regulation being put on businesses," said financial analyst Scott Garliss of Stansberry Research. 

The technology and pharmaceutical sectors in particular could then breathe a sigh of relief. They would not have to fear breakup or Biden's plans to control the price of medicines.

The oil and gas industry would also benefit if Trump's pro-business policies live on. Demand for energy is likely to benefit from the recovery of the global economy with increasing consumption and production and their continued existence would be assured for the time being, especially if the environmental curbs advanced by Biden fail to materialize.

Yet energy is not the only sector fueling a strong upward trend since the first positive vaccine announcements last month. So-called sector rotation is increasingly driving investors away from overheated technology stocks and toward much cheaper stocks.

Looking for value

"Value stocks are definitely going to snap back more because we're going to see the economy reopen," predicted Garliss, who spent more than 20 years on Wall Street. As stock markets tend to move six to eight months ahead of the real economy, many investors, he said, have already positioned themselves to benefit from the move.

Those looking for outperformers should not necessarily stick to the stock market heavyweights either. Large companies are comparatively expensive because the economic recovery has already been priced into their share prices.

Companies with a small capitalization, on the other hand — a maximum market value of $500 million (€408 million) — are now in a better position, and not just because they are comparatively cheap, Garliss told DW.

A comparison of the major US benchmark indices shows that already this year, the Russell 2000, the index of small-capitalization stocks, has gained three times as much as the S&P 500. Companies with small capitalizations are benefiting, above all, from digitization. 

Pick your stocks wisely

Experts advise that anyone who wants to profit from these developments should take a very close look at individual stocks. Instead of relying on passive index funds, as in previous years the focus in 2021 will be on stock picking. 

"Investors will need to focus on the fundamentals of individual companies and sectors for results, which is why we expect actively managed strategies to outperform those that passively invest across an index," recommended Lisa Shalett, chief investment officer of wealth management at Morgan Stanley. Successful investing may require shifts in asset allocation, sector, geography and stock selection, she added.

In addition, non-US stocks are likely to perform much stronger going forward. "China could become the world's largest economy in the next few years, so companies that trade with China could also outperform," Shallet said. The most favorable buying opportunity will be found in emerging markets, where valuations are currently still attractive, unlike in the US, she says.

But even the US should end up with a relative stock market boom. After all, in the first two years of a new bull market, stocks tend to gain a good 65%, according to an analysis by asset manager LPL Financial.

"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," wrote Brian Belski of BMO Capital Market in his stock market forecast. However, only those investors who choose their shares very carefully in the future are likely to profit from this.

This article was adapted from German