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Investment Outlook

10 predictions for 2021: The world improves, but do markets already know?

Robert C. Doll
Senior Portfolio Manager, Chief Equity Strategist
10 predictions for 2020

A look at our old and new predictions 

10 Predictions for 2020: Scorecard

A light at the end of a very long tunnel

At the start of the year, we expected economic growth to pick up modestly and were encouraged by seemingly diminishing macro risks, such as trade policy. Conversely, we were concerned by relatively full stock valuations and thought that market gains could be limited following a strong 2019. The unanticipated coronavirus pandemic and resulting economic and market upheaval threw all of this for a loop. The (mostly) new predictions we offered in April were based on our expectation that the crisis would peak in the second quarter, paving the way for a slow economic recovery in the second half of the year. Below, we offer scoring and commentary on our full list of predictions.

1. Original: The world avoids recession in 2020 as U.S. GDP grows over 2% and global GDP grows over 3%.
Scorecard for wrong
Update: The U.S. and world experience a sharp, but reasonably short recession with noticeable recovery before year-end.
Scorecard for correct

We didn’t quite get to the twelfth year of the expansion, as the outright halt in economic activity pushed the world into a sharp and deep recession. With the sharp jump in growth in the third quarter, however, the deepest recession in post-World War II history also proved to be the shortest one. The pace of growth may continue to slow, but we expect the year as a whole will witness an expansion.

2. Original: Inflation and the 10-year U.S. Treasury yield end the year above 2% as the Fed stays on hold through the election.
Scorecard for wrong
Update: All-time low yields move higher during the second half, with the 10-year Treasury closing the year above 1%.
Scorecard for half-correct

The 10-year Treasury yield plummeted to record lows during the heart of the crisis in March, and has since been moving in fits and starts. The yield did get close to 1.0% several times in 2020, but closed the year just below that level. As economic growth improves and investors move back into risk assets, we think bond yields will rise modestly in 2021.

The economy should move from recovery to expansion in the year ahead.


3. Original: Earnings fall short of expectations, partially due to rising wage rates.
Scorecard for correct
Update: Earnings collapse, but rise smartly by the fourth quarter.
Scorecard for correct

Going into 2020, we thought earnings expectations for the year were too high. Earnings collapsed in the first and second quarters before rebounding smartly in the third. And it appears corporate profits could actually hit an all-time high in the fourth quarter. Critically, we have seen a notable dispersion between sectors and industries, with areas like technology and health care outperforming those hit hard by economic closures.

4. Stocks, bonds and cash all return less than 5% for only the fourth time in 25 years.
Scorecard for wrong

This is one of the three predictions we left unchanged. Stock prices have been extremely volatile this year, and hit record highs toward the end of the year (the S&P 500 Index rose 18.4% for 2020). With the Fed anchoring short-term rates at zero, cash returns have been minuscule. Bonds performed better than we expected (The Bloomberg Barclays U.S. Aggregate Bond Index was up 7.5%), but could experience headwinds if longer-term yields rise.

5. Original: Non-U.S. stocks outpace U.S. stocks as the dollar retreats.
Scorecard for half-correct
Update: The dollar weakens as global growth strengthens in the second half.
Scorecard for correct

This prediction was originally based on our view that the U.S. dollar would fall and non-U.S. stocks offered better relative valuations. The weakening dollar has been one of the major market stories in 2020. Since the midpoint of the year, the dollar is down –7.7% as investors moved out of safe-haven assets and as global growth has been strengthening. Massive U.S. deficits have also dragged on the value of the dollar.

While near-term risks for stocks remain elevated, we also believe global equity prices will be higher one year from now.

6. Original: Value and cyclicals outperform growth and defensive stocks.
Scorecard for half-correct
Update: Value and cyclicals outperform growth and defensive stocks in the second half.
Scorecard for half-correct

The Russell 1000 Value Index (2.8%) was significantly behind the Russell 1000 Growth Index (38.5%) for the year. Value also lagged in the second half of the year (22.8% versus 26.1%). The cyclical/defensive situation happened as we expected, however: An equal-weighted basket of cyclicals was up 13.9% for the year and 23.5% for the second half, while defensives lagged at 5.6% and 12.9%, respectively.

7. Original: Financials, technology and health care outperform utilities, real estate and consumer discretionary.
Scorecard for correct
Update: Financials, technology and health care outperform utilities, energy and materials in the second half.
Scorecard for correct

For our original prediction, a basket of financials, technology and health care was up 18.6%, while a combination of utilities, real estate and consumer discretionary trailed at 10.5%. Regarding our revised prediction, our list of favored asset classes was up 22.7% in the second half of 2020, and a basket of our least-favored asset classes climbed 15.1%. Technology and health care should continue to do well in an environment of quantitative easing, and the financials sector appears undervalued.

8. Active equity managers outperform their indexes for the first time in a decade.
Scorecard for wrong

This is the second of our predictions that did not change. This trend held true earlier in the year, but the massive rally that took hold in November caused many active managers who were underweight value sectors to lose ground. Heading into the close of the year, only 36% of active managers were beating their indexes.

With valuations looking high, investment selectivity will be critical in 2021.


9. The cold wars within the U.S. and between the U.S. and China continue.
Scorecard for correct

This is our third unchanged prediction. And, sadly, it proved to be correct. An optimist would hope that Americans would have used this time of crisis to pull together, but the opposite is the case as political and social divisions within the United States worsened through 2020. And the relationship between the U.S. and China (and, indeed, China and the rest of the world) appears to be deteriorating as the countries move from being competitors to adversaries.

10. Original: The U.S. concludes a tumultuous political year with a status quo election.
Scorecard for half-correct
Update: The coronavirus recession and rise in unemployment cause Donald Trump to be a one-term president.
Scorecard for correct

President Trump’s popularity and poll numbers have been dropping and the possibilities of a Democratic sweep of the White House and Congress are growing. As 2016 showed us, however, election surprises can’t be ruled out. Should a sweep occur, it would represent a substantial change in the government’s tax and regulatory policies that could significantly impact financial markets.

10 Predictions for 2021

The world improves, but do markets already know?

Stocks have a lot going for them in 2021. The economy should improve, the Fed is set to remain accommodative and earnings should continue to recover. But investor expectations are high heading into the new year, suggesting that downside risks could materialize.

1.  U.S. real GDP increases at its fastest pace in twenty years.

While there are still swaths of weakness in the economy (e.g., in the travel, leisure and entertainment sectors), many areas have benefited during the pandemic (such as parts of technology and health care). Consensus GDP growth for 2021 is 3.8%; our view is it will come in at more than 4%, making it the strongest annual economic growth rate so far this century. We expect the economy to move into expansion mode by the third quarter (or maybe even by the second quarter).

2. Inflation approaches 2% as the 10-year U.S. Treasury yield reaches 1.5%.

Consensus expectations are for interest rates and inflation to move higher, but our target levels for 2021 are the consensus targets for 2022. A key factor in our view is the Fed’s change to target an average inflation level rather than an inflation peak. We also think higher commodity prices, dollar weakness and sector moves within equities point to higher rates and inflation.

3. The U.S. dollar sinks to a five-year low.

After a significant rise in the dollar early in 2020, the greenback has declined notably, but has simply moved from the higher end to the lower end of a five-year trading range. The notable deterioration in the U.S. balance of payments and net savings rate, coupled with our expectation that global growth will eventually rebound faster than U.S. growth, causes us to believe that the dollar will break below this trading range in 2021 as the trade-weighted dollar index approaches 85.

4. Stocks reach a new high for the twelfth consecutive year, but fail to keep pace with strong earnings growth.

The U.S. stock market has hit a higher high every year since 2009, and we expect that will happen again in 2021. But we also expect stocks won’t keep pace with earnings growth of more than 20%. In other words, 2020’s stellar stock market recovery (up nearly 70% from the March low) has probably “borrowed” some from 2021. Most observers (ourselves included) agree that stocks are not expensive relative to other assets (chiefly government bonds), but are expensive relative to historical absolute levels.

5. Stocks outperform cash, but cash outperforms Treasury bonds for the first time since 2013.

As prediction #4 indicates, we are constructive on equities for 2021. As prediction #2 indicates, we are cautious on interest-rate-sensitive securities. Logically, therefore, our view is that stocks will outperform cash and cash will outperform U.S. Treasuries next year. Stocks can be flat for the year and still outperform cash, since stocks currently yield more than cash investments. With coupon rates on Treasuries so low, it also wouldn’t take much of a rise in yields for cash to outperform Treasuries in 2021.

The key question as we enter 2021: How much good news is already priced into the markets?

 

6. Value, small and non-U.S. stocks (especially EM) outperform growth, big and U.S. stocks.

For many years, the place to be within equities has been U.S., large-cap and growth stocks. And while we are not advocating selling that trio, non-U.S., small-cap and value stocks have come to life and outperformed on a relative basis — a trend we expect will continue. This rotation won’t be a one-way street, but relative cheapness of non-U.S., small and value – coupled with expectations of economic and earnings improvements – should be solid catalysts for this to happen.

7. Health care and financials outperform energy and utilities.

Health care offers good earnings growth and reasonable valuations (assuming political headwinds don’t develop). Financials appear very undervalued and we expect loan growth to resume, which should help the sector. Energy (where demand seems weak and supply seems plentiful) and utilities (where a general cyclical earnings pick-up, along with modest inflation and interest rate upticks would hurt) look less attractive.

8. U.S. federal debt rises to more than 100% of GDP on its way to an all-time high.

The coronavirus pandemic has resulted in a massive explosion in fiscal aid and stimulus that has taken the U.S. federal budget deficit from 5% of GDP in 2019 to 15% in 2020. Debt exploded to 100% of U.S. GDP during World War II in the 1940s. But it declined to less than 30% in the 1970s, largely through a rapidly expanding postwar economy. We project debt will exceed 100% of GDP again next year and rapidly head higher as spending increases and as interest rates rise.

9. The U.S./China cold war continues, but the conversation becomes quieter and more multilateral.

The U.S. currently leads the world economically, technologically and militarily. But China aspires to supplant the U.S., taking action in all three areas. While their approaches differ, both Republicans and Democrats share a major concern regarding China’s ambitions. One of President Biden’s first priorities will be to attack the issue multilaterally, in contrast to President Trump’s unilateral approach. U.S./China relations will continue to have a significant impact on capital markets in the years to come.

10. Despite polarization, President Biden, Senator McConnell and moderate forces achieve some compromise legislation.

Although this prediction and hope may be optimistic, we think some “at the margin” compromise legislation may be passed. Senate Majority Leader Mitch McConnell (assuming the Republicans win at least one of the two Georgia runoff elections on January 5) and President-elect Biden spent decades together in the Senate and have a reasonably cordial relationship. We also take hope from the group of moderates from both parties that was responsible for restarting conversations regarding the year-end aid package.

Key themes for investors

Matching goals to investments

The beginning of the year is often a time to review investment goals and adjust asset allocation decisions. We suggest focusing on the following areas as you assess your portfolio:

Stick with long-term plans: The next few months could continue to be rough, and volatility could be elevated. But we encourage investors to think long term, focusing on diversification and portfolio rebalancing.

Look for tactical opportunities that may come from active management: In an environment where gains may be tough to come by, we suggest focusing on geographic and style differences, as well as bottom-up considerations such as cash flow and earnings sustainability. Similarly, we encourage investors to be nimble and flexible as they approach the markets.

Selectivity also matters in fixed income: With low yields and the prospect of continued rate volatility, fixed income investing has become more challenging. Investors may want to rely on active managers with the flexibility to respond to market changes and the investment acumen to remain ahead of their peers in uncertain markets.

Alternatives can play multiple roles in a portfolio: Alternative assets – including real assets, real estate and other investments – may provide diversified sources of risk, return and/or income. We also think equity strategies such as long/short or market neutral have the potential for diversification compared to long-only, benchmark-oriented investments.

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Sources
All market data from Bloomberg, FactSet and Morningstar Direct
Active management data from Bank of America Merrill Lynch Research

The views and opinions expressed are for informational and educational purposes only as of the date of production/writing and may change without notice at any time based on numerous factors, such as market or other conditions, legal and regulatory developments, additional risks and uncertainties and may not come to pass. This material may contain “forward-looking” information that is not purely historical in nature.

Such information may include, among other things, projections, forecasts, estimates of market returns, and proposed or expected portfolio composition. Any changes to assumptions that may have been made in preparing this material could have a material impact on the information presented herein by way of example. Past performance is no guarantee of future results. Investing involves risk; principal loss is possible.

All information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such. For term definitions and index descriptions, please access the glossary on nuveen.com. Please note, it is not possible to invest directly in an index.

A word on risk
All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investing involves risk. Investments are also subject to political, currency and regulatory risks. These risks may be magnified in emerging markets. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk and income risk. As interest rates rise, bond prices fall. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. An alternative strategy sells securities that it has borrowed but does not own (“short sales”), which is a speculative technique. A strategy will suffer a loss when the price of a security that it holds long decreases or the price of a security that it has sold short increases. Losses on short sales arise from increases in the value of the security sold short, and therefore are theoretically unlimited. Because a strategy invests in both long and short equity positions, the strategy has overall exposure to changes in value of equity securities that is far greater than its net asset value. This may magnify gains and losses and increase the volatility of returns. In addition, the use of short sales will increase expenses. Diversification does not assure a profit or protect against a loss. CFA® and Chartered Financial Analyst® are registered trademarks owned by CFA Institute.

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