2020 has proved to be an extremely difficult year for investment professionals in the business of forecasting stock market performance. While most tend to look to the past to provide clues for potential future activity, this year has proved there was no historical playbook to guide investment decision-making given the global pandemic-driven disruption to not only financial markets, but to society as well.
In fact, 2020 is a year that will likely go down in the history books for far too many important and obvious reasons. As such, we think it is safe to say that personal and professional lives intertwined more than any time in modern history during 2020 and led to periods of heightened emotion, fear, rhetoric and overreaction that clearly impacted decision-making and produced one of the most unprecedented stock market periods in history. Granted, a once-in-a-century global pandemic, a month-long cyclical bear market, massive amounts of fiscal stimulus and Fed intervention, a compressed recession and a contentious US presidential election tend to rattle the cages. All of this only fueled the preponderance of negativity that has surrounded Wall Street for most of the past 20 years.
In fact, we believe this “pre-destined negativity” had never been more evident than during the depths of the global pandemic chaos in the first quarter, leading up to a “pessimistic crescendo” thanks in part to the contentious election and another wave of the pandemic in the fourth quarter. We believe this environment led many investors to make excessively binary investment decisions, tactics that lacked process, discipline and most of the time facts and analysis, in our view.
Unfortunately, such behaviors are hard to unwind – and will likely continue to define stock market trends for several more quarters, if not years, in our view. As such, we believe the believability factor of the bull market will be questioned yet again in 2021. While continued investor indecision and lack of commitment will undoubtedly drive sharp price moves, we believe much of the apprehension will center on the validity of unprecedented earnings growth as fundamentals more broadly recover from the depths of 2020. Therefore, investors should brace themselves to rely less on traditional variables or models and be prepared to incorporate some more unconventional methods to value and assess the market overall.
Even with recent positive vaccine and treatment developments, the global pandemic and its unprecedented impact are unlikely to fade in coming months. As such, the massive fiscal and monetary response in the United States and around the world (also unprecedented) will likely remain in place for the foreseeable future. Such environments have historically supported continued stock market gains and we see no reason why 2021 will be any different.
Yes, valuations appear stretched at first glance, but they also need to be considered within the context of historically low interest rates and little inflation, ingredients that are likely to persist throughout 2021 and beyond, in our view. When viewed through this lens, we believe it is not unreasonable for market valuation to sustain (or even expand slightly from) current levels. Thus, we forecast that the S&P 500 will reach 4,200 by 2021 year-end.
In addition, we believe corporate earnings growth is poised to recover sharply from pandemic lows, particularly during the second half of next year, since we believe much of the damage was lockdown-specific and not necessarily related to companies themselves. In fact, our 2021 S&P 500 earnings per share forecast of US$175 represents an almost 35 per cent jump from the pandemic-depressed 2020 trough levels. This implies that 2021 has the potential to be one of the best years ever in terms of earnings growth, something we believe will also help to push stock prices higher.
Our 2021 price and earnings forecasts for the U.S. stock market are predicated on the following assumptions: 1) one or more effective vaccines become publicly available sometime during the first half; 2) at least one more round of fiscal stimulus in the range of about US$1-trillion; 3) policy uncertainty (particularly on the trade front) declines; 4) the yield curve continues to steepen as 10-year Treasury rate drifts higher, but stays below 1.5 per cent.
Three keys to positioning during 2021
We anticipate that market conditions will slowly transition back to normal throughout 2021, but the path is unlikely to be smooth, to say the least. A move away from binary and momentum-laden investment decisions toward more fundamental ones is likely to be one of the first key signs, particularly as overall earnings growth recovers. Once this occurs, we also expect that macro factors, such as stimulus or action by the Federal Reserve, will become much less important for investor consideration. Finally, we believe both keys will lead to a third one, where market performance will broaden out instead of relying on a handful of stocks to fuel further gains.
Consumer discretionary, financials and industrials represent our overweight sectors in the S&P 500, while energy, real estate and utilities are our underweight sectors. We are market weight communication services, consumer staples, health care, information technology and materials.
Canada is still undiscovered value
U.S. stock-market and economic resilience have been overarching global investing themes over the past decade, which will likely remain the case in our view. However, Canadian stocks have also shared these trends to a certain extent. Although Canada has generally underperformed the U.S. over the past decade, Canadian stocks have managed to outperform most global markets over the past five years despite the S&P/TSX Composite’s large overweight in energy and materials, areas that have generally been under pressure during this time.
Indeed, we believe Canada remains well positioned to benefit from both a return to stability and the improving North American economy, given it has one of the strongest trading and business relationships with the U.S. of all global markets. As such, our overriding theme for Canadian equities remains, “As America goes, so goes Canada.”
Furthermore, we believe there remains an attractive value proposition within Canadian equities for those investors that would like to increase their U.S. growth exposure. Yes – Canada as a value play – especially when examining non-resource sectors. This is particularly true within sectors such as consumer discretionary, industrials and financials, where companies have relatively high U.S. revenue exposure and have shown consistency and pliability in the face of difficult operating environments.
Therefore, as investors continue to deal with the unprecedented nature of 2020 and challenges that remain for 2021, Canadian stocks are likely to once again march toward new all-time highs. As such, we forecast that the S&P/TSX will reach 19,500 by 2021 year-end, which would mark a new record high. On the earnings front, we expect Canada to exhibit a trend similar to the U.S. and forecast $1,100 for 2021 S&P/TSX earnings per share, which would represent a more than 40-per-cent jump from the pandemic-depressed 2020 level.
Consumer discretionary, financials and industrials represent our overweight sectors in the S&P/TSX Composite, while real estate and utilities are our underweight sectors. We are market weight communication services, consumer staples, energy, health care, information technology and materials.
Brian Belski is chief investment strategist with BMO Capital Markets.
Your time is valuable. Have the Top Business Headlines newsletter conveniently delivered to your inbox in the morning or evening. Sign up today.