Investor Optimism May Be Too High
On the surface, it’s understandable why stock prices have been soaring over the last month. The good news on the vaccine front portends economic normalization next year, the U.S. election produced no major surprises, monetary policy should remain hyper-accommodative, fiscal support should continue and negative real rates for government bonds are supportive for risk assets.
But that outlook doesn’t reflect some significant risks, and all of this good news is already priced into the markets. Earnings expectations for 2021 and beyond suggest a very strong recovery from levels that were only moderately depressed in 2020. Stock valuations are elevated by historic standards, and credit spreads are quite tight. And we may still see additional economic lockdowns in the coming months as the pandemic worsens before it gets better.
As such, we think markets are ripe for disappointments and investors appear overly optimistic about the prospects for stocks and other risk assets. At this point, we think markets look overbought and equities have probably “borrowed” some of 2021’s returns, meaning we could be in for a period of consolidation or correction in the near future.
Beyond a period of uncertainty over the next few months, we think the outlook is brighter. We expect stocks to deliver moderately positive returns next year, with U.S. earnings rising somewhere around 20%, offset by a modest decline in valuations. Geographically, we also think improving global growth makes emerging markets equities particularly attractive and expect non-U.S. stocks to outperform the U.S.
Robert C. Doll is senior portfolio manager and chief equity strategist at Nuveen.
Sources:
All market data from Bloomberg, Morningstar and FactSet
Employment data from the Department of Labor
Manufacturing data from the Institute for Supply Management
Election odds from PredictIt