Big, sweeping stock market forecasts are the ones that draw the headlines, but the ones to pay attention to are those that only look one to two months ahead or 10 to 20 years ahead. That's because one-year predictions will be disrupted by exogenous events, unlike a very short- or long-term outlook.
For those compelled to forecast financial markets in 2021, the first place to start is the Federal Reserve. The second is the federal government. Monetary and fiscal policy are the two biggest inputs to financial markets, and we don't seem to be getting a lot of restraint in either.
In essence, the two major conditions that led to strong market performance in 2020 will still be present in 2021, along with one additional one: COVID-19 vaccine shots.
The thoughtful Wall Street types point out that the starting point for valuations is much higher than at the bottom of previous recessions. But it's difficult to make predictions based on valuations, because extremes in valuations can always get more extreme. For evidence, just take a look at some of this year's biggest gainers.
Another thing to consider is the huge sentiment implications of the recent elections and how they are pushing the public discourse away from polarization and toward moderation. Six months ago, people were getting killed in left vs. right street battles. Now, we're arguing about whether Jill Biden should address herself as "doctor." If history is any guide, political moderation is great for financial markets.
As for interest rates, we're in a bit of a pickle. With an expanding economy, longer-term rates should rise from these record low levels, and the difference between short- and long-term bond yields should expand. But from a practical standpoint, rates cannot be allowed to rise very far because the federal government has borrowed so much that there's the potential risk of insolvency. The upside is that with former Fed Chairwoman Janet Yellen poised to become the next Treasury secretary, there is the potential for a great deal of coordination to ensure that the Fed continues to monetize the nation's debt.
In reality, all that strategists really do when making their year-ahead predictions is look at what happened the last couple of months and extrapolate it out a year. In this case, that means value stocks outperforming growth stocks, a weaker dollar and rising commodity prices. It's possibly those trends will continue, but the only reliable prediction to make is that there will be plenty of surprises in 2021.
Jared Dillian, investment strategist at Mauldin Economics, wrote this for Bloomberg Opinion.