- After a rollercoaster year for markets, investors will still face threats to their portfolios in 2021.
- From further coronavirus woes to higher interest rates, the risks you need to know about for next year are laid out below, courtesy of some of Wall Street’s biggest firms.Â
- Visit Business Insider’s homepage for more stories.
If you’ve kept up with the latest research on Wall Street, two overriding things will have been drilled into you by now: the economy will bounce back, and stocks are set to soar in 2021.
Indeed, here are the price targets for the S&P 500 â€” which currently sits at about 3,700 â€” by December 2021 from some of the world’s biggest investment banks:
Goldman Sachs: 4,300
Morgan Stanley: 3,900
Credit Suisse: 4,050
But these predictions are based on assumptions which may not prove to be true â€” something the banks themselves acknowledge.
Alongside their estimates, strategists have published a myriad of risks, some overlapping, that threaten to end the stock market’s euphoric victory laps.Â
We’ve compiled many of these risks below, along with commentary from some of Wall Street’s most influential voices.
Vaccine distribution hurdles and demand
Though multiple vaccines are finally here after months, many have expressed worries about their distribution, as well as public willingness to receive them. Goldman Sachs’ Chief US Equity Strategist David Kostin is among those concerned.
“Core to our equity market forecast has been the assumption that an effective vaccine is delivered and widely distributed in the US by 1H 2021,” Kostin wrote in a December 18 note. “However, the first week of vaccine distribution has proven that the logistics of proper delivery are complex and uncertainty remains around the number of doses that will be distributed in 1H.
“Vaccine demand will also be an important driver of the recovery,” he continued. “Based on a YouGov poll, 41% of the population indicated it would get vaccinated, while 28% was “not sure” and 31% indicated it would not get vaccinated. A mismatch in vaccine supply and demand would represent a downside risk to our forecast, as would a slower-than-expected rebound in consumer activity even if distribution proceeds smoothly.”
Further waves of COVID-19 and lockdowns
Hand-in-hand with vaccine hurdles comes the risk of further COVID-19 outbreaks and lockdowns.Â
Morgan Stanley says this could cause a switch out of cyclical stocks.
“That could lead to a rotation back toward the work-from-home beneficiaries and away from the reopening stocks that rallied so much on last week’s vaccine news,” the bank’s Chief US Equity Strategist Mike Wilson wrote in a November 30 note.
“This could be painful as many were forced to buy into it recently,” he added.
As with every virus, COVID-19 has the ability to mutate. And this week, two new variants were discovered globally: one in the UK and another in South Africa. Both show signs of increased transmissibility, making them even harder to combat with social distancing measures.
This news wiped 3.93% off the MSCI European value index, signalling inventors concerns; however, the index remains up around 19.45% since early November on the positive vaccine newsflow.
As the world’s principal reserve currency, the value of the US dollar and its potential to depreciate is never far from investors minds.
But why would this present a potential headwind, especially as some countries try to devalue their currencies to make their exports more attractive?
It could exacerbate a rotation out of US assets, causing a sell-off in the US equities investors have been largely overweight during the crisis. This could make life “a lot easier for emerging markets,” and we could see a big rotation there, said Kiran Ganesh, a multi-asset strategist at UBS Global Wealth Management.
The risks would be threefold: Firstly, it could cause a “de facto tightening” of financial conditions in Europe, at a time when the ECB is running out of levers to stimulate the economy, Ganesh said.
Secondly, there is a risk that higher inflation in the US might reduce the Fed’s appetite to do more, he added.
Lastly, some investors have been “borrowing cheap in euros and investing in USD assets,” a well-known trade that has been effective in recent years but might cause problems going forward, he said.
Moreover, it could promote a renewed discussion about currency wars, he said, a debate that was only perpetuated by the US’ recent branding of Switzerland as a currency manipulator.
Rising inflation and interest rates
While insufficient stimulus poses a threat, all of the cash that the Federal Reserve and Congress have flooded markets and the economy with also poses a threat in the form of inflation, which has been stagnant for years.Â
This could cause a rise in 10-year Treasury yields, giving investors an incentive to step out of riskier equities.
“Although Treasury yields remain low in historical terms, the speed of any increase matters. Equities have historically been able to digest gradually rising long-term interest rates, particularly when driven by improving growth expectations,” Goldman Sachs’ David Kostin said in a December 18 note.Â
“However, equity returns have historically declined when rates rise by more than 2 standardÂ deviations in a month (~37 bp today…),” he added.
A significant upswing in long-term rates could be devastating for global markets, according to Eric Vanraes, portfolio manager of the Strategic Bond Opportunities Fund and head of fixed income investments at Banque Eric Sturdza SA.
“In my opinion, a massive steepening of the curve would lead to a major global financial crisis because equities could collapse, and the economy could collapse, because if long-term yield increased sharply, all of the mortgages will be at risk in the US and consumption will decrease. If you have to pay more for your mortgage, you will not spend and private consumption is still 70% of the [US] GDP,” he said in an interview on December 4th.
Georgia runoff flips the Senate blue
Since the week of the US election, stocks seem to have been pricing in a Biden presidency with a split Congress â€” a divided government outcome, meaning minimal change is in store.
But with two Senate runoffs in Georgia set to be held in early January, there is still a chance the Senate flips to a Democrat majority, meaning the party would have more power to implement its agenda over the next two years.Â
Were this to happen, it could cause a sell-off both because of the market’s apparent pre-pricing behavior thus far, and because of its implications for regulation and tax policy.Â
Still, Goldman Sachs says such an outcome wouldn’t have a limited long-term effect on the market.
“We ultimately see upside in equities beyond January, regardless of the election outcome, given our economic forecast and the tradeoff between fiscal and tax considerations,” Kostin said in a December 18 note.
He added: “Regulation has also been in focus for investors as antitrust lawsuits were recently filed against both FB and GOOGL. We found that previous examples of antitrust lawsuits resulted in valuation contraction and a downshift in sales growth for involved firms (Competition, concentration, and regulation). These stocks comprise 50% of the Communication Services sector. In November, we downgraded the sector to Underweight.”
If Democrats do win both seats and take control of the Senate, it is unclear how severe a potential sell-off could be.Â
Brian Walsh, senior financial advisor at Walsh & Nicholson Financial Group, told Business Insider in November that such a downturn could last months and drag markets into correction territory.
“It’s something that could last 3-6 months I think,” he said. “Not necessarily a recessionary event, but definitely a corrective event with a 10-15% drawdown if we do have a blue wave come through, simply because of all the tech gains that are going to have be taken off the table for capital gains tax purposes, especially with Biden’s tax policy being to increase capital gains tax rates.”
If this scenario unfolds, Walsh said investors should look to utilities, industrials, materials, and ESG stocks.
One of Donald Trump’s political legacies will be his protectionist rhetoric against the ever-growing power of Chinese corporations, built somewhat on global supply chain dependence. The trade war was a palpable risk to the stock market throughout his term.Â
But, it would be naive to think that this foreign policy is unique to Trump’s political wing.Â
Anti-China sentiment can be found on both sides of the aisle, meaning investors should not expect a light touch to foreign policy from the incoming Biden administration, although he might avoid the use of tariffs, UBS’ Ganesh said.
But after the aggressive Trump-era war, China has no strong reason to be particularly “friendly” towards the US either, he added.
Investors have been in a state of pure bliss since the election and vaccine announcements.Â
But for Charles Schwab’s chief strategist Liz Ann Sonders, the euphoria may be going too far now â€” especially considering the breadth of the market’s recovery has begun to deteriorate, she told Business Insider on December 17.
“Where you tend to get a bigger problem is if sentiment is really, really elevated, and then you start to see a brisk deterioration in the market but sentiment just stays optimistic,” Sonders said. “That to some degree is what happened in the early part of 2000. You started to see some underlying deterioration in what was going on in the market, but sentiment was like, ‘nope, doesn’t matter, it’s a new paradigm.'”
She added: “What I’m concerned about is if the little bit of deterioration we’ve seen in breadth conditions recently persists, and it doesn’t dent optimism at all, then I think there’s a greater likelihood of an actual correction â€” something more in the 10% realm versus what we’ve had since the March low.”