Annual stock market forecasts have a pretty poor track record. For proof, consider last year. At the end of 2019, the median consensus on Wall Street was that the S&P 500 would rise 2.7% in 2020. In April, after the market’s pandemic related plunge, a Bloomberg survey showed forecasters predicting that the S&P 500 would end the year down 11%. Both forecasts, as we now know, were way off the mark. In a year of unprecedented economic and political turmoil, the S&P 500 ended the year up 16.3%.
Despite their poor track record, most people still crave the perceived certainty that forecasts impart. This can be especially dangerous in investing where a growing consensus over an asset’s rosy potential can lead to overvaluation. Consider the expected boundless future of fiber optic cable during the Tech Bubble or widely anticipated appreciation potential of real estate during the Financial Crisis. The robust stock price gains over the past year are, once again, based on a growing, optimistic view of the economy going forward. This consensus includes the following assumptions.
Further economic stimulus will limit economic harm. While consensus around the need for further fiscal stimulus is growing, Congress seems remarkably good at not getting things done. Limiting further economic pain will require crafting an aid package that gets sufficient funds to the right people quickly. This will be the new Administration’s first key test.
The economy will rebound in the second half of 2021. Economists recently surveyed by the Commerce Department expect modest growth in the first half of 2021 to be followed by a sharp escalation in the second half. This optimistic outlook is based on the near universal view that vaccinations will be successfully deployed between January and June. Again, details matter here. Vaccination production needs to continue at a rapid clip, distribution efforts need to improve from current levels, and sufficient people must sign up. Finally, we need to acknowledge that much about the current crop of vaccines, including how long the resulting immunity lasts and the degree to which they protect against newer mutations, remains unknown.
Inflation may rise but will stay under control. Inflation has been remarkably muted, averaging 1.5% over the past decade. While many of the forces that have kept it in check remain in place (globalization, technological advancement etc.), it is hard to ignore the inflationary threat posed by the recent historic level of monetary stimulus. Inflation typically only results when funds pumped into the economy begin to circulate (i.e., monetary velocity accelerates). So far, widespread price increases have not occurred. But as the chart above shows, prices have picked up for some goods while prices across the service sector (think lodging, restaurants etc.) have fallen. Once the economy begins to recover, this dynamic could shift as consumers unleash pent up demand and resume spending.
Interest rates will remain low. Interest rates here in the U.S. have been falling for most of the past 40 years. The Fed has signaled that they do not expect to change course any time soon given the current weak state of the economy and dormant inflation levels. But it is important to acknowledge that the Fed is in somewhat unchartered territory given the sheer size of recent fiscal stimulus efforts. If vaccines do allow a return to more normal life and spending patterns, things could change quickly. Even signaling a reduction in bond purchases (vs. an outright rate increase) could send long-term rates, which the Fed only indirectly controls, higher. Low interest rates have had a pervasive impact on the economy, supporting everything from stock prices to unprecedented borrowing levels across the economy. The consequence of rising rates would be serious. This is the issue to keep an eye on today.
