9. Investor optimism may be elevated, but it also may be too early to call for a period of equity market consolidation. Trying to adjust portfolios by timing specific market moves is almost always a fool’s errand. But momentum tends to wane before corrective phases begin and it remains quite high.
10. Improving economic growth in 2021 should favor cyclical and non-U.S. stocks. We think an environment of stronger and more synchronized global growth, ongoing monetary and fiscal stimulus and a weaker U.S. dollar should relatively benefit these areas of the market.
Two Risks To Consider: Higher Rates And Rising Inflation
Optimism remains extremely high as investors focus on prospects for a better outlook in 2021, while ignoring likely near-term economic disappointments that could deepen as the pandemic continues to get worse. In addition, we think investors are not paying enough attention to two possible risks that could start to affect stocks: rising interest rates and growing inflation pressures.
Markets are currently pricing in the likelihood that bond markets will remain stable and yields will hover at or near historic lows for years to come. We think these assumptions will start to get challenged in 2021. Rates will likely start to move unevenly higher, with long-term economic growth likely to improve and central bankers and other policymakers around the world doing everything they can to engineer more inflation.
In the recent past, interest rate spikes were dramatic enough to trip up stock markets even with nonexistent inflation pressures, which occurred periodically in 2018. It has not been easy for policymakers to generate inflation in recent years, but we expect many will be surprised by an uptick in inflationary pressures in the coming decade.
From an equity perspective, we think long-term earnings expectations may be too high given this backdrop. Earnings will likely recover noticeably in the coming year or so as the economy improves, but long-term expectations beyond that time appear inflated (especially in the U.S.). Stocks should still make gains in the coming years, but investors may need to temper their expectations and focus on being more selective.
Robert C. Doll is senior portfolio manager and chief equity strategist at Nuveen.