Last year’s stock market was nothing short of chaotic and there’s reason to believe this year could be just as bad. In this video, I’ll walk you through the ten market-moving events that could shake stocks in 2021, scenarios nobody is expecting. We’ll look at what might happen, how likely it is and how to invest if it does.
Nation, this is one of my favorite videos to do each year, a look ahead at different scenarios and how to invest in stocks for each. It’s these changes to the market consensus, that direction in the economy and stocks, that is going to make you higher returns in your portfolio.
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We’ll start with a quick look at the 2021 stock market, what assumptions are investors making for stocks. That’s going to give us a baseline to see how these nine scenarios would change things and how you should be investing ahead of time. I’ll then reveal each scenario, how likely it is to change the market and how to prepare.
I’m going to be ordering these from the least to most likely so make sure you stick around to the end for those events that will definitely happen and change the direction in stocks!
Now as we’re talking about each of these scenarios, remember the market is said to be forward-pricing, taking the most likely picture for earnings over the next six to 12 months and pricing stocks for that. It’s why you can get higher stock prices in the middle of a global pandemic even when the economy is falling to pieces, the stock market looks beyond the current problems into possible scenarios.
So your job as an investor is to think about these nine possible events, each of which are not yet priced into the market because they’re unexpected, think about how to invest in stocks if each were to happen. Where is the market WRONG and where are you going to make as much money as possible?
To start off, let’s look at what the stock market is currently pricing in for 2021, what do investors think will happen?
Analysts polled by FactSet Research expect earnings to jump by 22% in 2021, the blue shaded bar on the right. If that happens, it would be the highest since 2010 and on sales growth of just 7.9% expected. So the market expects those earnings to come roaring back and to justify the high stock prices of today.
On a stock sector level, stocks in the industrials and consumer discretionary are expected to be big winners with earnings growth of 78% and 59% this year. Stocks in the energy sector are also expected to post a big earnings boost but earnings were negative last year so the growth rate can’t be calculated.
What’s even more interesting though is that stocks in the Tech sector and Communication Services are expected to post earnings growth between 13.7% to 14.5% which is way below that average 22% growth for the market.
Why this could be a problem is that tech and the communications sector is now 38% of the S&P 500 index, almost half of the market is from just these two sectors.
So what happens here if these two sectors lag the market, really don’t see that big earnings growth and these stocks underperform? It makes it very difficult for the broader market, that S&P 500 index, to head higher if these two sectors aren’t rocketing like they did last year.
Overall, analysts expect the S&P 500 to rise 8.5% in 2021 to about 4,040 with stocks in the index expected to report a combined $169.83 in per share earnings. That means the market is trading for 23.8-times on a price-to-earnings basis…it’s highest since 2000 and 28% above the 10-year average.
So clearly, right now, the market is pricing in a very optimistic outlook for 2021!
And that’s where these nine what-if scenarios come in. What happens to the stock market if each happens, how likely are they to happen and what should you be doing how to invest in stocks?
So jump in your time machine and let’s look at the nine what-if market scenarios for 2021!
New Strain of Coronavirus
One of the least likely scenarios but also one of the worst would be a new strain of the Coronavirus that sets us back to zero on a vaccine. Health workers in the U.K. discovered a new strain of COVID19 early December that passes more easily between people and accounted for 60% of new infections around London.
In response, the U.K. restricted holiday travel and the EU cut flights from the country. The move caused the price of oil to plunge 4% and pressured the market for days.
Researchers at the WHO estimate the new strain has the potential to be 36% more transmissible than the more common form of Coronavirus though it doesn’t appear to be deadlier.
Now new strains of a virus are nothing new. Some virus mutate frequently. It’s why you have to get a new flu vaccine each year to protect against the new strain while you only need one measles shot.
So this new strain isn’t too much a worry but the possibility for the COVID virus to mutate into something that doesn’t respond to the current vaccine is way more likely. If that happens, expect a big selloff in the market and those tech stocks that have done so well, like Fastly, ticker FSLY, Square, and Docusign to boom higher.
Social Media Breakup
Our next scenario here, a social media platform is forced to breakup, though we’re still into the long-shot events here in the list this one is more likely over the next couple of years.
The Department of Justice and states’ attorneys general have filed antitrust suits against Facebook and Google recently with this being pretty much the only thing Democrats and Republicans see eye-to-eye on.
The government is arguing that Facebook’s acquisitions of Instagram and Whatsapp gives it monopoly-like powers on social content and should be forced to sell them off. In the case against Google, it’s the combination of Google search and YouTube that gives it an unfair competitive advantage in online advertising.
But you know how fast the government moves on things…like snail pace, so this will probably take years rather than happen in 2021.
When it does happen though, and I do believe it’s a matter of when, not if…there is the case to be made that investors could see higher returns on the separate companies.
When the seven ‘baby bells’ were split off from AT&T in 1985, investors booked an average 498% return over the following decade. That’s an annualized 19% return and almost twice the market return of 10% a year over the period.
Analyst research has estimated that the value of both Facebook and Google could be higher if they were to separate their segments. Google Search, YouTube and Google Cloud are estimated to be worth at least the current market cap of the company. Then you add in more than $130 billion in cash and the ‘Google Other’ businesses that include Google Play and branded hardware. Revenue from these other businesses accounted for $14 billion in 2019 revenue and at the current P/S ratio would add another $100 billion in market cap…all told, sum of parts for the company is about 17% higher than current share price.
So here I think you can take any selloff on the shares, especially if it's related to those antitrust suits, and use that as a buying opportunity.
A rebound in the value of the U.S. dollar is our third what-if scenario here and this one definitely isn’t priced into the market because most think the greenback is going the other way in 2021.
In fact, analysts at Citibank think the dollar could fall another 20% this year, and that’s after it’s already dropped about 12% from its March peak. The value of the dollar against a basket of other currencies like the Euro and Chinese Yuan is approaching the lowest its been since 2018 and even further before that.
Now the value of the dollar might not seem like it matters as much but this has very real consequences for the economy and stock market earnings. We’ll look at the effect of a weaker dollar in our next scenario but what if the greenback strengthens instead?
This usually happens during economic uncertainty or a market selloff, as global investors rush to the safety of the US dollar and push the price up. Since commodities like oil are priced in dollars, it forces those prices lower which hit stocks of energy companies and the overall market usually suffers.
If that happens, bonds probably aren’t going to be the safety investment they have been in the past. Rates are so low right now that bond prices won’t go up that much to protect you from a stock market selloff.
Here your best bet is going to be investing in the safe haven stocks and companies with less foreign revenue like utility companies and telecom carriers. Good picks here would be something like FirstEnergy Corporation, ticker FE, or telecom giants like Verizon or AT&T.
A little more likely is that the dollar continues to weaken and maybe even further. Ray Dalio has been calling for a dollar crash for years and while I don’t think the greenback will plunge, the downward pressure is definitely there.
Between huge U.S. deficits, low interest rates and a gradual loss of reserve status, the value of the dollar could easily lose another five- or ten-percent this year.
Another 10% depreciation in the dollar would take it to levels seen only once in the last 50 years and could cause a massive shift in the economy.
Since commodities are priced in dollars, a cheaper greenback would mean higher prices for gold and oil. That combined with higher prices for anything imported could bring a big bump in inflation.
Besides buying shares of energy stocks and gold miners, you could also position in companies that book most of their revenue from outside the United States. As the dollar falls, those sales booked in a foreign currency become more valuable when translated back into the dollar. So here we’d be looking at companies like Philip Morris International, ticker PM, or semiconductor companies like Qualcomm or Skyworks Solutions or others here with more than 87% of total sales from overseas.
Trillion-dollar Infrastructure Bill
This next scenario could actually be a big boost for the market, passage of a trillion-dollar infrastructure bill.
This one has long been a promise of campaigns but just hasn’t happened in the hyper-partisan government where neither side wants to give the other a win.
But that doesn’t mean it can’t happen and we could be closer than ever. The House passed a $1.5 trillion infrastructure bill last summer with $500 billion for highways, bridges and public transit but it never got passed the Senate. President-elect Biden proposed a similar $2 trillion plan but we just have to see if McConnel will take it up with Republicans.
The American Society of Civil Engineers gave the U.S. a D+ in its most recent evaluation, and while the group is biased to more infrastructure spending, there’s definitely a need here.
If it happens, look to buy stocks of materials companies and the heavy equipment makers. This would be stocks like Caterpillar, ticker CAT, U.S. Steel which is ticker X and Martin Marietta Materials, ticker MLM.
That’s five scenarios that are likely but not certain. Now for these next four, we’re going to be getting into the scenarios that are very likely to actually happen and that could cause big movements in stocks.
First here is a retaliation by Iran against Israel or the United States. Officials in Iran blamed Israel for the late November drone attack that killed a top nuclear scientist and promised an aggressive response.
Possibility of a New War
It’s similar to the incident last January when a U.S. drone strike killed one of the top Iranian generals and the country retaliated against U.S. bases in Iraq.
While Iran is going to want to generally play it cool to reenter a nuclear deal with the U.S., officials there are under extreme pressure to mount some kind of response. Missile attacks have been used to save face but not inflict too much casualty and could be used again but cyberattacks are increasingly becoming the norm.
I highlighted five cybersecurity stocks after the incident last year and they’ve produced an average 163% return over the period with shares of ZScaler jumping 345%!
ZScaler and CrowdStrike, ticker CRWD, are getting a little expensive but can still be good long-term picks. The legacy cyber providers like Fortinet, ticker FTNT, Palo Alto Networks, ticker PANW, and FireEye, ticker FEYE, are great prices here though.
This next one could be what brings the market back to reality in the first quarter, a new wave of retailer bankruptcies.
Last year saw that first wave of bankruptcies with 17 iconic brands filing and more than 9,500 stores closed but 2021 could be even bigger.
You see, most retailers have been holding on for dear life for the fourth quarter, that magical season that traditionally has taken consumer goods companies into the black on profits.
And even though retail sales weren’t too bad for the holiday season, the 22% increase in online sales sucked all the life out of that traditional shopping market. Any retailer without a very strong online channel got a lump of coal for Christmas.
Now with no hope for the next three quarters, we could see another wave of bankruptcies by retailers and restaurants.
The upside to this though, is that the retailers able to make it through these next two quarters are going to have less competition. They’ll be able to pick up market share online and in traditional brick-and-mortar sales.
So like we’ve been doing last year, you want to watch the balance sheet of your companies to make sure they have that cash survivability. Target and Walmart have done well with grocery sales helping to bring people to the stores but Kohl’s, ticker KSS, and Nordstrom, ticker JWN, may offer higher return potential. Both are down more than 25% last year and should survive the retail apocalypse.
Kohl’s focus on off-mall locations helped it in sales when the malls closed down and Nordstrom went into the pandemic with fewer stores and a healthier balance sheet.
Our two biggest market-moving scenarios and this one would be problems with the vaccine distribution.
Nation, we’re just getting started on the greatest logistical challenge in the history of the human race! Trying to get seven billion people vaccinated and that means 14 billion doses because you need two hits of the vaccine…it’s not something that’s going off without a hitch.
By comparison, the U.S. vaccinated about 175 million people against the flu in 2019 and that was a decade high. Now we’re talking doubling that amount against COVID plus vaccinating against the flu at the same time.
So from manufacturing problems to getting the doses distributed to problems with the extra cold storage they need, something will go wrong but will it move the market?
Pfizer said last year that it would cut its initial vaccine target in half due to supply chain issues though it still expects to distribute a billion doses by the end of 2021. But this is just the beginning and issues could come up with anything from supplies of vials, needles and distribution. Add in the problem of keeping these vaccines at negative 100 degrees Fahrenheit and there will be bumps.
The cut to Pfizer’s target didn’t spook the market too much but a slower than expected rollout could be a hurdle for the market. I would position in companies along the process like CVS, which we have in our 2021 Bow-Tie Nation portfolio, and Fedex, ticker FDX, which should benefit all year on that distribution.
Market and Economy Clash
And the scenario most likely to play out, a good economy but weak market returns.
This would be an ironic twist to what we saw last year when the economy was a dumpster fire but the stock market soared. And the outlook really comes from two factors.
First is again the idea that the market is forward-pricing so it’s already priced into stocks a lot of that rebound this year. Investors are already expecting 22% earnings growth and it’s unlikely that’s going to happen next year, so that reversion to normal growth is going to take some enthusiasm out of stocks.
The second reason the stock market could underperform the economy goes back to the idea that 38% of the market index is in tech stocks and communication services, exactly the kind of stocks that boomed in the lockdown.
So as life and the economy gets back to normal, the stocks in those sectors might not do as well and that’s going to hold back the returns on that broad market index like the S&P 500.
What you can do for this is consider ETFs outside the index, so funds targeting specific sectors that should do well like healthcare and financials rather than investing in the market index, that SPY fund, or in the tech sector.
About the Author
Joseph Hogue is a financial expert and investment analyst. After serving in the Marine Corps, he started his career investing in real estate before becoming an investment analyst for some of the largest private investors. He's appeared on Bloomberg and on CNBC as an investment expert and has published ten books in personal finance. Now he helps investors reach their financial goals and invest in the stock market with some of the same advice he used when working for the rich.