Typically for the end and start of a trading year, investment houses deliver a forecast for the period ahead. Just like businesses build a budget of expenses and revenues, investment houses look at the factors that might influence the market and make a forecast.
The consensus for this year is that the stock market in the United States will make new highs. It already reached all-time highs in 2020, but it appears that the bullish trend will continue, should nothing significant changes in the meantime.
What are the main factors behind the bullish forecast?
Abundance of Cash and Declining Volatility
According to JP Morgan, the market is poised to make another leg higher. By the market, we mean the S&P 500, long viewed as the benchmark for the overall market.
The investment bank expects no less than $1 trillion of investment inflows in the equity market, driven by hedge fund positioning and share buybacks, among others. Unsurprisingly, at this pace, stocks will outperform bonds, with the risk-on sentiment poised to continue into the new year.
The consumer discretionary, financials, and the energy sectors are favored. The analysis points to the S&P 500 rising to 4,400 points in 2021, well above the current 3,700 level.
Truth be said, most of the S&P 500 companies hold record balance sheet cash. When that happens, companies have multiple options. First, they may choose to invest it and pursue opportunities – basically growing the business, hence the potential profitability. Second, they may choose to buy back their own shares. Why would a company buy back its shares? This is just another way of rewarding its shareholders, similar to paying a dividend. Third, by keeping a strong cash position, companies improve their liquidity needs and can easily react to adverse conditions (e.g., prolonged pandemic).
VIX, the volatility index, is seen as dropping from the 2020 levels. When volatility declines, that is a bullish sign for the stock market, as panic selling leads to a rise in volatility.
If we add to the mix the ongoing support from the Federal Reserve and the stimulus that keeps coming from the U.S. Congress, we may say that the 4,400 target is not only realistic but even modest. What are the risks to such a forecast?
One is that the transition of power planned for January 20th will not be that smooth as many believe. Another is that the pandemic will take longer.
At this point, though, investors have all the reasons to bid for stocks in 2021.