U.S. stocks are closing 2020 on a strong note, and many investors are betting the party will continue after a tumultuous year that marked both the end of the longest bull market and the shortest-lived bear market ever.
Risks abound, including a resurgent coronavirus pandemic, concerns about the speed of rollout of vaccines and a high-stakes Jan. 5 U.S. Senate runoffs in Georgia for the balance of power in Congress. Still, many investors are looking past these threats.
“We are going to continue to see a push higher,” said Commonwealth Financial Network’s head of portfolio management, Peter Essele, who sees stocks in the early stages of a multi-year bull run.
The options market is pricing in more volatility in January than December, likely due to the Georgia elections. If Republicans win at least one Senate seat, they will maintain a slim majority. If Democrats sweep the dual runoffs, the chamber would be split 50-50 and the tiebreaking vote would go to Vice President-elect Kamala Harris, giving President-elect Joe Biden’s party full sway over Congress. That raises the possibility of tax-reform proposals that many investors fear would hurt stock prices.
Still, most investors are not looking for a sharp pullback next year. BofA Global Research’s December fund manager survey was the most bullish.
The roll out of coronavirus vaccines has emboldened investors, along with the U.S. Federal Reserve’s expressed readiness to keep policy accommodative, strategists said.
Indeed, the U.S. stock market’s rally over the last two months may have taken even bulls by surprise. A late November poll found strategists expected the S&P 500 to end 2021 at 3,900, which would be another annual rise after the index rose about 15.5% percent this year to 3,732.
In prior bull markets, when the S&P 500 takes out its previous bull market high, the index has experienced a median gain of 38% over the span of 26 months before topping out, according Bespoke Investment Group data.
Some investors fret that the COVID recovery may already be priced in and valuations may be stretched. The 12-month forward price-to-earnings ratio of the S&P 500 is currently about 22, well above its long-term average of 15.
Still, investors see several parts of the market, including financials, leisure and hospitality stocks and energy with potential to rally.
“The market, overall, does not seem overbought,” said Tim Ghriskey, chief investment strategist at Inverness Counsel.
Investors looking for a continued rally are optimistic of a rebound in corporate earnings. “Earnings are going to be used as a confirmation of current pricing,” Essele said.
S&P 500 company earnings are forecast to increase about 23% in 2021 compared with 2020.
For much of this year increased market concentration has been a nagging worry for investors, with top five S&P 500 constituents generating 127% of the index’s return during the first nine months of the year, according to BlackRock’s calculations.
Technology’s weight in the S&P 500 currently stands at 28%, up more than 10 percentage points from its historical average since 1990, according to Bespoke.
“What we saw in November and December is that the market already started broadening out … beyond the tech stocks, the mega stocks,” said John Praveen, portfolio manager at QMA, a PGIM company, pointing to a strong showing by value stocks, shares of small caps and non-U.S. stocks.
The golden run by some high-flying growth names could still continue, investors said.
“Do not count out those growth companies with dominant and emerging business models that can continue to meet or exceed lofty shareholder expectations,” said Tony DeSpirito, chief investment officer of U.S. fundamental active equity for BlackRock in a note.
With vaccines being deployed investors are looking at “the light at the end of the tunnel,” said Praveen, who expects this year’s laggard stocks and sectors to join the rally in 2021.
“Think of it as your car firing on all cylinders… it’s a much broader, healthier rally,” Praveen said.