Potential Financial Market Drivers In 2021

As we position client portfolios during the early days of 2021, we are looking for potential opportunities that have or may emerge as well as attempt to identify some of the events that might be the catalyst for a pullback.

As always, we shun prognosticating and point to last year as evidence that movements in the financial markets are impossible to consistently predict over the short-term, but historically very predictable over a full economic cycle, which last six to ten years. Some of which are noted below.

Putting the pandemic entirely behind us will be a multi-year process, rife with fits and starts. It is therefore prudent to remain diversified and not commit too large a percentage of one's assets to either growth or value.

The Democrats and Republicans will work closer together than most expect in order to get some things accomplished which may include another round of stimulus and a 2022 tax package. However, we are not as frightened as many of the Democrats moving too far to the left and believe that the sway of power lies mostly with the middle, the centrists.

Consider that of the 100 U.S. Senators, there are perhaps 40 on the left and 40 on the right whose votes adhere strictly to party line. That leaves the final 20, the Democratic Senators in red states and the Republican Senators in blue who will be keenly aware of the fact that how they vote on the Senate floor will impact their chance for reelection.

This would also apply to those in similar position elected to the House of Representatives.

The S&P 500 rose 14.87% to close out the final two months of 2020, marking only the sixth time since World War II this index rose double digits to close out the year. Statistically, this is quite bullish for the subsequent year as each of the previous five times this has occurred the S&P 500 went on to post double digits gains (Source – LPL Research).

Despite the above, we believe that the rally that ended 2020 may have pulled forward gains from 2021 and after the tailwind of pension and IRA deposits early in 2021, the market is ripe for a pullback, one that would remove some of the froth that has accumulated and allow for future gains.

As a result of all of the financial stimulus and hopefully the end of the pandemic, there will be a global economic expansion, one which will broaden out the returns of the equity markets, to include mid- and small-caps as well as those in emerging markets. This will also result in more balanced returns when comparing technology to other sectors of the market.

The yield on the 10-Year U.S. Treasury note will end up closer to 1.50% than 1.00% after closing out 2020 at 0.94%. However, the move will be gradual and will not provide a headwind to the equity markets, but to fixed income. It will be viewed positively by investors like "rain after a long drought." Banks and other financials should benefit if this move in yield comes to fruition.

However, at some point in time in 2022, the higher yields may provide competition for stocks should this advance continue.

After some of the excesses are wrenched out of the more speculative areas of the market, long-term, institutional dollars will flow more heavily into alternative energy (hydrogen, solar, wind, fuel cells, electric), artificial intelligence (AI), genomics and fintech. ESG is here to stay.

Although traditional energy companies may have a cyclical tailwind as the economy improves bringing along with it demand, the fact that they are in a secular decline becomes more apparent.

Americans as well as citizens from other countries, cooped up from the pandemic, begin to travel in earnest during the second half of 2021 and well into 2022. We believe a partial repeat of the "Roaring '20's" will occur which should benefit companies associated with the travel industry. However, those returns will favor some more than others as business travel will be slow to recover.

In fact, it may never recover in its entirety as teleconferencing has become much more prevalent as a result of the pandemic. That said, by the end of the year there will be more in person meetings in 2021 than in 2020 but not nearly as many as in 2019 or during previous years.

Given our belief that interest rates will trend higher as a result of stronger economic growth, we favor lower credit quality issues over more credit worthy companies; junk over investment grade; and investment grade as compared to sovereign debt.

We prefer the intermediate portion of the yield curve.

Bond prices move inversely to interest rtes. Therefore, the move down in interest rates during 2020 pushed bond prices higher. In fact, more than two-thirds of the total return of the Vanguard Total Bond Market Index ETF (BND) can be attributed to this decline in rates. Should that decline cease or as we believe reverse itself, bond market prices would ease, pushing total returns lower.

The potential "stagnation" of total returns would benefit some equities. However, it would most likely also negatively impact interest-rate sensitive sectors such as traditional utilities, telecoms and consumer nondurables.

The evolution in retail from brick and mortar to online continues at a brisk pace, despite the likely easing of pandemic restrictions as the vaccine gets rolled out. This will therefore continue to favor companies dominant in online retail as well as those traditional retailers that continue to adapt to online consumption.

Please note that all data is for general information purposes only and not meant as specific recommendations. The opinions of the authors are not a recommendation to buy or sell the stock, bond market or any security contained therein. Securities contain risks and fluctuations in principal will occur. Please research any investment thoroughly prior to committing money or consult with your financial advisor. Please note that Fagan Associates, Inc. or related persons buy or sell for itself securities that it also recommends to clients. Consult with your financial advisor prior to making any changes to your portfolio. To contact Fagan Associates, Please call (518) 279-1044.