January is certainly off to a great start. The S&P 500 is up 1.8%, so far this year, the Dow Jones Industrials are 1.6% higher, and the Nasdaq has advanced 2.4%. A couple of weeks ago, we mentioned the potential for a “Santa rally,” where an analysis of the last five trading days of the calendar year and first two trading days of the new year provides, historically, a decent gauge for the next 12 months.
This year, the S&P 500 was up 1% over these seven days. It is a short sample, but ending the year on a strong note and getting off to a great start in the New Year reflects positive investor sentiment. Despite this historic trend, as we previously pointed out, it is never wise to place too much weight in such a short sample size. Instead, it is better to place more emphasis on economic and financial conditions.
Although we saw some political instability around the certification of Joe Biden’s presidential confirmation, the markets continued to charge full force, especially after the Democrats secured two Senate seats to take control of the Senate. Because Democrats have only a one-vote advantage, it is far less likely that major overhauls to taxes and health care or a Green “New Deal” and other ambitious legislation will get passed. According to Bespoke Investment Group, if you go back to 1901 and examine periods where Democrats controlled both legislative chambers:
Now again, each time this occurs, different circumstances and economic conditions exist; but based on this second historical trend, the odds of a good year ahead appear higher. Even the bond market is expecting a strong 2021.
U.S. Treasury yields started rising again last week, as the 10-year yield finally surpassed the 1% mark for the first time in quite some time. This is an indication that investors are expecting faster growth and more spending in 2021, especially as stimulus checks are on the way. Biden has also made promises that the recently passed $908 billion stimulus package would be a “down payment,” with more stimulus to come.
The U.S. dollar continues to be weak and, as we wrote in a prior update, we expect the dollar to be weak throughout the year. With a weaker dollar, commodity prices tend to rise (they are priced in U.S. dollars). This creates an uptick in inflation. Traditionally, stocks and real estate do well in an inflationary environment. So, with rising inflation and low interest rates, this should create strong demand for stocks throughout 2021.
Also, now that a lot of the political uncertainty is behind us, the markets can also refocus on the economy and upcoming fourth quarter earnings season. FactSet analysts have forecasted the S&P 500 should achieve year-over-year earnings growth of 22.1% for 2021. This is more than double the 10-year average growth rate, which has been 10%. Additionally, revenue growth is expected to rise almost 8%, which is also nearly double the 10-year average revenue growth rate, which has been 4.5%.
Investors are also closely watching COVID-19 vaccine deployment to see how effective it will be in the fight against the virus. The more success in containing the virus, the better the odds for more favorable economic conditions in 2021.
Putting this all together, there are quite a few positive catalysts ahead for the markets. But, it is important to be wary that valuations get further stretched each time investor optimism soars to a new height. Unfortunately, when optimism gets too high, it tends to foreshadow a decline of some sort. We have to be prepared for a pullback in the near future. However, any pullback will provide a great opportunity to get some cash to work. We continue to advocate dollar cost averaging and adding money to the markets on any dips.
2021, just like 2020, will have its own set of challenges, but the new year is also a great time for new beginnings. We remain thankful that we serve a God that is unchanging. Our circumstances may change, but He is always faithful.
Because of the Lord’s great love, we are not consumed, for his compassions never fail. They are new every morning; great is your faithfulness. I say to myself, “The Lord is my portion; therefore, I will wait for him.” – Lamentations 3:22-24.
We look forward to what 2021 has in store for us!
Sources: Yahoo Finance, Reuters.com, and JP Morgan Market Insights
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