2020 has been a year for the history books. There's been tragedy and devastation on so many fronts including the economy. So, it's rather surprising that the S&P 500 (NYSE: SPY) is ending the year with a 15% gain. However, this leaves out a 35% plunge that happened from mid-February to mid-March during the initial phase of the pandemic.
2020 Recap
Going into 2021, it's important to understand this strength in order to devise the ideal strategy for 2021. The market's strength can be attributed to three primary factors. One is that economic activity remained relatively resilient. Some parts of the economy like travel, restaurants, and services were demolished, others saw increased activity like housing and tech. Further, there was incredible amounts of monetary and fiscal stimulus which patched up some chunk of lost economic activity.
Finally, corporate earnings, on an aggregate level, surprised to the upside. In Q3, the S&P 500's earnings were only 3% lower than the previous year. This is due to the fact that goods-producing companies were less impacted by the pandemic, while tech companies saw earnings accelerate, offsetting losses in many sectors.
2021 Outlook
And, the market is clearly optimistic about the future given that it's up more than 10% to new, all-time highs over the past two months. Earnings will have to be quite strong in 2021 to validate the market's optimism.
Some reasons to expect earnings to remain strong are that short-term rates will remain low which will lead to increased share buybacks. Additionally, the vaccine and economy reopening mean that a big headwind will turn into a tailwind. Further, there are signs that a new cyclical upturn in manufacturing and industrial activity is beginning which will add another tailwind to economic growth and is confirmed by strength in commodity and material stocks.
The government's fiscal stimulus has also led to household balance sheets being in great shape which is also supportive of future growth. Strength in housing is correlated with strong consumer confidence. Additionally, there remain pockets of pain in the economy due to the coronavirus negatively impacting many groups. From a human level, this is terrible but from the stock market's perspective, it means that the government will continue to provide support to the economy which is bullish for asset prices.
Strategies
Due to these factors, the latter half of 2021 could feature GDP growth above 10%. Most believe that vaccination efforts will be complete by the second quarter. The next couple of months are going to be brutal with rising case counts and potential lockdowns in many areas as some hospitals are getting overloaded once again.
However, the market is willing to look past this. It's evident by looking at the price action of stocks that benefited from these exact conditions like Amazon (Nasdaq: AMZN), Target (NYSE: TGT), or Walmart (NYSE: WMT). These stocks soared higher on the combination of rising case counts, lockdowns, and government stimulus. We have identical conditions right now, but it's the airlines, hotels, and online travel websites that are breaking out to new highs, while these stocks are underperforming.
Investors should focus on the improving intermediate-term picture. This means investing in companies that will benefit from the economy reopening. In addition to travel-related sectors, this will benefit restaurants, retail, and REITs. Another beneficiary will be energy stocks as demand bounces back, while supply remains impaired.
Strong economic growth also means that long-term interest rates should increase which will steepen the yield curve which will lead to gains for banks. Another consequence of rising long-term rates is that tech stocks could see multiple contraction. This means that some of the biggest winners of 2020 could be losers in 2021. This is already somewhat apparent with stocks like Zoom (Nasdaq: ZM) down by 40% over the past couple of months.