Over the next 12 – 14 months stock markets will act as weighing machines between the positive and negative forces that exist in the world. Ultimately, the direction and magnitude of movement for stock markets will be determined by the balancing of these positive and negative forces.

What we think:

Widespread vaccination and the subsequent “reopening” of economies should allow economic growth to surge in the second half of 2021. 

The combination of positive sentiment and high valuations in US stocks will hold back returns, because much of the good news is already baked into current prices.

More predictable trade policy from the US will lead to stronger international growth and a weakening of the US dollar in relative terms.

With democrats holding a small majority control of Congress it is likely we see more stimulative fiscal policy. This furthers the case for a weakening dollar and international stocks.

It is likely that we see a steepening of the yield curve over the next year. The Fed seems poised to maintain very low short-term rates until “maximum employment” is reached. A widening spread between short-term & long-term rates would be a positive for financial stocks.

Earnings should rebound in 2021. However, US stocks will likely be constrained by valuations that are historically high. This bodes well for international and emerging market stocks which have much lower valuations relative to US stocks.

What does it all mean:

While I believe stocks are in the early stage of the next great bull market cycle. High valuations and overly positive sentiment create an environment perfect for market corrections and a temporarily sideways market. Earnings need to catch up with prices.

Investors should use corrections as an opportunity to invest idle cash, and/or rebalance their portfolio heavier to stocks.

Investors should overweight to international & emerging market stocks relative US, because of attractive relative valuations, and a weakening dollar. Investors should overweight cyclical, and small cap stocks which will see bigger bumps in the early part of the recovery.