3 Stock Market Risks That Aren’t a Covid Stimulus Package

NYSE

Congress has finally passed another pandemic relief bill, and while President Donald Trump has thrown a wrench into its quick passage, the path of stocks is highly dependent on three other factors: the Georgia Senate runoff, the rollout of Covid-19 vaccines, and the decline of the U.S. dollar.

The S&P 500 has already had a strong fourth quarter and is up 9.5% since Nov. 3, just before the presidential election. There seems to be reason for optimism: The $900 billion fiscal stimulus bill, passed on Tuesday, will enable cash-starved small businesses to rehire workers when vaccines roll out. Investors also now expect billions of doses of vaccines to be distributed within the next year.

Lately, stocks have been in “consolidation” mode, taking a pause in their rally. This allows earnings estimates to catch up to prices, dragging valuations down. Since December 4, the S&P 500 is essentially flat. and of course, risks remain. Here’s what investors should focus on now.

Georgia

Investors are eyeing the Georgia Senate runoff results coming Jan. 5. In Georgia, a Senate candidate must have the majority vote to win the election—if that doesn’t happen, the top two vote-getters face off in a separate race. The outcome of this year’s Senate races in Georgia will likely decide which party controls the Senate. If Congress remains divided—with a Republican majority in the Senate and a Democratic majority in the House—fiscal spending would likely be lighter than in a Blue Wave scenario, removing one layer of economic support. That is a negative for consumer discretionary, manufacturing, financial, and other economically-sensitive stocks. A Blue Wave, however, could mean stricter regulations on banking, fossil fuels, and health care.

Vaccines

Longer term, the most important market driver will be vaccines and their distribution. “The vaccine was the number-one issue keeping investors up at night,” wrote Lori Calvasina, chief U.S. equity strategist at RBC Capital Markets in a note summarizing the bank’s investor survey. “The positive outlook for the stock market and the economy would deteriorate if expectations for a smooth vaccine rollout are not met.”

The U.S. Food and Drug Administration so far approved two vaccines—one from Pfizer (PFE) and BioNTech (BNTX), and another from Moderna (MRNA).

The Dollar

Another downside risk for the stock market for the next year or so is continued U.S. dollar weakness.

“One potential market risk is a USD collapse, which is a longer-term worry of many clients,” wrote Dennis DeBusschere, head of portfolio strategy research at Evercore in a note.

RBC’s survey shows 69% of investors think the dollar will soon weaken, up sharply from 46% in September. The U.S. Dollar Index (DXY) is down 12% since March 20, which was the peak of global investors’ move into haven assets. The global economy is expected to recover faster than the U.S., which has weighed on the greenback.

Some analysts expect that if the Dollar Index falls below 89, it could drop another 10%.

A weak dollar makes foreign securities more attractive to hold and would likely put some pressure on U.S. stocks. However, the dollar could soon reverse its recent downward trend and move higher, once global economies move past easy growth comparisons in 2021—and global growth potentially resumes at a lower pace than in the U.S., Lindsey Bell, chief market strategist at Ally Invest told Barron’s. That would be positive for U.S. stocks.

The good news is that while downside risks to U.S. stocks are present, earnings momentum is also on the market’s side. Analysts expect double-digit earnings growth in percentage point terms for the S&P 500 for the next two years.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com