Analysts’ Pick: A review of 2020 for equities; what to expect for stocks in 2021
- An imbalanced recovery in 2020 suggests that while the broad index likely still has room to rise, sector and market cap centric positioning will probably be more beneficial
- Market breadth hints at excessive optimism, and that a possible downside correction may be due soon
- A robust growth path will still hinge on the containment of the virus, implicitly meaning that lockdowns remain a key risk that markets will look out for
A new year has begun, and we will look at financial assets from a year-in perspective of what has happened and what is likely to come. For equities, the S&P500 in particular, the run up in valuations in 2020 may have seemed excessive, but it is important to realise the economic recovery we have seen so far has mostly been skewed towards specific sectors. More recently, that has started to change, pushing positionings out of more defensive sectors in favour of cyclicals and small cap stocks. While we expect it to continue, increasingly optimistic investor sentiment may be a signal that we are reaching a short-term correction point for valuations. Despite this, we are still bullish on the full year forecast for risk assets in the year, in particular for equities and commodities as the economic environment likely warrants better rewards for more risk-on plays.
A year in review of 2020 shows that the market was very much skewed in performance thanks to strong gains in the tech sector. This needs to change for there to be a robust rise in the S&P500 moving forward. The same can be said of valuations, with almost all sectors in the S&P500 trading at premiums (forward price-to-earnings ratios) much higher than its three-year averages. Both findings suggest that while short-term market optimism is strong, there are pockets of opportunities at the sector and market cap level of the market that will likely outperform the broad S&P500 index.
Sector performance has been mostly skewed towards tech
In addition, market breadth shows strong momentum across S&P500 stocks since November 2020, with the over 90% of members in the index rising past their 200-day moving average. The last time that this number of stocks in the index reached this level was in 2013 and late 2009. This suggests that the recovery has been strong and fast. Fundamentally, this is supported by political certainty (US presidential elections in November) and the announcements of vaccine offerings from Pfizer-BioNTech, Moderna and AstraZeneca-Oxford. While this can be taken as a signal that there may be some over-optimism in the market and a correction is due, the inclusion of RSI in the analysis suggests that this momentum has not reached its peak, at least not yet. However, we expect good news to be coming to an end, and short-term headlines will more likely take over control of the market. Implicitly, this means that there is a growing risk of downside-skewed volatility in the short-term which has yet to materialise.
Investor sentiment looks skewed towards excessive optimism and may be indication of a possible correction
Still, a correction at this point is likely to only be a healthy one in our view, assuming vaccine efficacy rates hold and there is not another unforeseen economic shock. Our outlook for equities as a result remains overall skewed towards the upside this year. This is backed up by both the current economic environment where interest rates are unlikely to be hiked by the central banks to avoid another taper tantrum-like event that was seen in 2013, along with pent-up demand that is already being seen in the manufacturing sector (ISM survey respondents have been growing increasingly optimistic of the demand outlook). More vaccines are also expected to come into play as we come towards the end of the quarter, which in our opinion is more likely to be the time period where we see a real robust growth in the economy. This would mean that we anticipate some resistance at the 3849 level for the S&P500, and possibly a short-term correction towards 3589 in the first quarter before it progresses higher through 2021.
For now, risk in relation to lockdowns resulting from the Covid-19 infections will likely remain at the top of the list, especially as the new mutation (with preliminary studies showing its higher rate of transmissibility) of the virus has already been reported to be present in New York The UK is already experiencing the impacts of that due to the severe strain on its health care system, forcing England into lockdown measures similar to that seen at the onset of the pandemic in 2020. If we do see the same happen in the US, expect a deeper-than-expected correction in the short-term as it is unlikely that investors will be able to shrug off the short-term dent in the economy resulting from that.
SPX continues to show good momentum on the back of positive vaccine developments but does look to be slowing down in the short-term. Expect some resistance at the 3774 level to break into new highs. We assume today’s Georgia elections to be a catalyst depending on who wins, but that movement is unlikely to be material to the overall outlook as the broad economic recovery is still likely in the US thanks to the deployment of vaccines. Still, technicals suggests that there is room for a dip in the index especially with both the MACD and RSI trading close to the top end of the historical spectrum.
Support: 3589 / 3407 / 3234
Resistance: 3774 / 3849 / 4098
SPX Chart (D1)