End of the year summary and my thought for the New Year:

With the market right near record highs, it’s easy to forget the amount of uncertainty that existed nine months ago when the S&P 500 made its COVID low. To refresh your memory,

March 23rd, 2020 was a very different world from January 1, 2020, and December 24, 2020 is also very different from both of those periods. As good as things may look for the market now, never lose sight of how things stood back then.

In last year’s outlook, I noted that “The two biggest enemies of a bull market are rising oil prices and higher interest rates. Closing out 2019, yields are sharply lower, and oil is off its highs of the year. Can an unexpected shock to the system suddenly flare up and derail the bull market? Anything’s possible, but that’s a hard strategy to invest based on.”

So here’s what happened in 2020, oil and interest rates both declined and an unexpected shock to the system is exactly what I got. In fact, shock may not even do justice to the pandemic which completely upended the entire global economy and societal norms in the process. While a lot of investors were scared out of the market in late March, hindsight shows that doing nothing was better than doing something and proving the point that investing based on unexpected shocks to the system is hard.

The comments above show that despite all the efforts at this time of year by analysts and strategists to tell you what will happen this year, nobody can. Regarding interest rates and energy prices, if the economy does resume its rebound from the lows in the first half, it would be very hard to imagine either of these bull market enemies falling in 2021.

So where is the market headed in 2021? If I haven’t provided targets in years past for the market in the year ahead, do you really think that after a year like 2020, where everything both conceivable and inconceivable seemed to come to fruition, I would even attempt to do that now? No thanks. I don’t pretend to know where the S&P will be trading twelve months from now. As illustrated later in this report, Wall Street strategist targets are just about always wrong in their forecasts. The whole game of strategists providing year end targets each year reminds us of Charlie Brown trying to kick a Football. Time and time again, he tries to get it right, but every time, Lucy has other plans.

Rather than tell you where I think the market will go in the year ahead, the purpose of our annual report each year is to look at the market from a variety of different perspectives to see whether they are acting as a headwind, tailwind, or no-wind. I then use that as a blueprint for positioning in the year ahead. It’s not a one-time assessment, though. I constantly monitor each area to look for changes or a continuation of the various trends and provide updates throughout the year. As you’ll see throughout the report, most of these factors aren’t unequivocally bullish or bearish for the market, but instead more nuanced.

Let’s get the bad news over with. Of all the factors facing the market, there’s not much positive to say about valuations. High or lofty may not even do justice as an accurate description to where things stand. The hard thing about valuations, though, is that they only matter when the market decides they do, and right now the market is busy celebrating. One of the only justifications for where equity valuations stand right now are historically low interest rates, but while equities look reasonably valued based on prevailing interest rates, if rates were to rise, the party may end without even a warning for last call.

A surge in Technology and tech-related stocks has been a driver of market valuations this year. As tech has rallied, concentration in the market has been a worry of investors throughout 2020. Technology’s weight in the S&P 500 currently stands at 28% which is more than 10 percentage points higher than its historical average since 1990. This kind of concentration makes ‘the market’ more tied to the fortunes of Technology, but it also means that if Technology does run into trouble, stock picking has the potential to shine over indexing.

As equities have soared off the COVID lows in March, investor sentiment has been gradually improving. While sentiment levels don’t indicate extreme optimism on a collective basis, some indicators are reaching concerning levels, and the recent performance of many IPOs and SPACs has no bearing in reality. “Mr. Market” would only be doing its job by pulling back a bit to keep this new breed of investor honest.

Analysts also remain bullish. Every sector with the exception of Communication Services and Energy have seen an increase in the percentage of buy rated stocks this year, and the S&P 500 itself has seen a 3.7% increase in the percentage of buy ratings. While analysts are more bullish, the average 7.5% spread between analyst price targets and current share prices is even wider now than it was heading into 2020 (5.9%).

Trends related to COVID remain negative and have impacted economic activity. In recent days, I have seen some signs of a receding in the third wave that has soaked the country, but with holidays on the horizon, a resurgence can’t be ruled out. For now, the market is looking ahead to a normal second half of 2021 as vaccines become more widespread. However, when you have a train moving as fast as the S&P 500 towards that light at the end of the tunnel, even a small bump has the potential to cause a big disturbance.

When and to what degree COVID releases its grip on the global economy remains uncertain. One thing for sure, though, is that COVID has changed the way of life for Americans in terms of how they live, work, relax, socialize, dine, and vacation. Some of these shifts will revert when COVID subsides, but others are likely to have a more lasting impact. For many Americans, working five days a week in an office is likely a thing of the past. A great way to track changes in behavior on the part of consumers is through our analysis of Google Trends data.

It seems quaint now, but a year ago at this time, the upcoming Presidential Election was front and center on everyone’s watch. I am happy to say that we made it through the strangest Presidential election in our lifetimes, and the market didn’t even blink. The results of the election didn’t please everyone, but the most positive thing I can say is that it’s over with.

Historically, equities have rallied under Democratic Presidents, and first years of a President’s Administration have seen a median gain of 9.6% with gains 60% of the time. Since 1928, the only Democratic President that had to contend with a down year in the S&P 500 in their first year in office was Carter. Political control of the Senate is still up in the air. While Democratic control of the Senate is feared by the market, full Democratic control in DC has typically been accompanied by positive returns. Any Democratic majority would also be extremely slim, making more extreme market unfriendly proposals less likely. In the end, though, who controls Washington is much less important to the market than longer-term secular trends.

Staying in Washington, the FOMC has helped credit markets which in turn has provided support for equities. As mentioned in our discussion of Valuations, low rates are positive for equity market performance, and when rates are this low, forward returns have generally been in line with their historical averages. Given the unequal impacts that COVID has had on different sectors of the economy, Chair Powell has made it clear that the FOMC will remain extremely accommodative until all of the economy’s stakeholders return to their pre-pandemic levels.

Investors couldn’t get enough dollars early on in the pandemic, but expectations for low rates in the future have reversed that trend pushing the US Dollar Index to multi-year lows. There isn’t a strong relationship between where the dollar is trading or how it performed in the prior year and how it impacts equity market returns in the following year, but based on current levels, market performance wouldn’t suggest weakness in equities in the year ahead either. Many large cap companies derive a large share of their revenues outside of the United States, so movement in the dollar is more sector specific than market specific.

Just like in 2017, bitcoin closed out 2020 on a torrid rally taking it to record highs in the process. While there are similarities between the two rallies, there are also key differences. Chief among them concerns who is buying it this time around. While the rally in 2017 was fueled primarily by retail speculation, this latest wave has had a lot more institutional support.

Commodities bounced in the second half of the year, especially oil prices, which briefly traded at negative levels in the first half. For the year, commodities as an asset class underperformed equities for the tenth straight year. In a world that’s seemingly gone all digital, it has been a lost decade for commodities.

There has been some signs of slowing in recent weeks as winter has set in, but based on trends in the majority of economic indicators I track, the economic recovery remains on track. It will probably feel more like a country dirt road than a smooth highway, but it will still keep us moving forward. Stimulus will also provide a needed boost, and the economic recession that began in February has likely been over for months now.

For most of the ten years coming out of the financial crisis, residential housing lagged the recovery in other sectors of the economy. Since the sector was coming out of the prior decade’s bubble, the fact that it lagged under the overhang of excess capacity wasn’t entirely surprising. That it took a global pandemic to spark the sector’s move probably surprised more than a few people. But when Americans have been forced to not only live, but also work, eat, socialize, vacation, learn, etc. from home, it makes complete sense.

The strong housing market has been a silver lining of the COVID crisis and has provided much needed support to the economy. Going forward, the outlook for residential housing still looks positive. As I mentioned earlier, some trends from COVID will reverse faster than others, but the theme of Americans spending more time at home—even if it’s hopefully a lot less than this year – will be another positive catalyst to the housing story. Ten years removed from the bubble popping, levels of housing remain far from lofty.

Lastly, the market itself. In prior bull markets, when the S&P 500 takes out its previous bull market high, the S&P 500 has experienced a median gain of 38% over the span of 26 months before topping out. Additionally, in prior bull markets that lasted 200 trading days or more, the S&P 500’s median performance over the next year was a gain of 13.4% with positive returns ten out of eleven times. The only time the S&P 500 was down one year later was during the 1982 – 1987 bull market, and even with a decline during that period, the early to mid-1980s certainly weren’t bad for equities.

From a seasonal perspective, the S&P 500 has averaged positive returns in three of the first four months of the year. In January, Technology, Consumer Discretionary, Health Care, and Real Estate have all averaged gains of over 1%, while Consumer Staples is the only sector that has averaged declines.

Again, rather than predicting how much the S&P 500 will go up or down next year, our goal here is listen to what the market and all of its different facets are telling us. The biggest cons out there are valuations, frothiness in areas like SPACs and IPOs, sentiment, and the fact that while rates are low, it’s hard to imagine them going much lower, especially if the economy continues to improve.

The positives come from the economy, which I believe is hanging in there, and the market itself. Trends in prior bull markets suggest that the year ahead will see positive returns, especially when all indications now suggest that the Fed will be dragged kicking and screaming out of its easy policy stance. Market internals have continued to support the rally and to this point have shown little in the way of a divergence. Likewise, high yield spreads remain near post-pandemic lows, and last but certainly not least, semiconductors have generally maintained their leadership.

As long as these trends remain in place, I think 2021 can be a ‘semi’ good year and even better relative to alternatives. Our biggest fear, however, is a sharp downside reversal in the areas of the market that have absolutely exploded in the last couple months of the year. The “Robinhood” trader has made a name for itself this year, but eventually — who knows when — the party in this space will end.

Thanks again, and Happy New Year!

Stocks on my Watchlist include:

PFSI –> 65.27 Cup with Handle pattern with a buy point of 67.87
ADP –> 176.56 Cup with Handle pattern with a buy point of 182.42
NVDA –> 519.75 Flat Base with a 587.76 buy point
TREX –> 86.29 Breakout over 81.33
DT –> 43.18 Cup with Handle pattern with a buy point of 45.28
DHI –> 71.85 Cup with Handle pattern with a buy point of 78.35
FTNT–> 149.79 23 Weeks Consolidation 152.05 Buy Point
ADBE –> 499.86 Double Bottom 519.70 buy Point
CHGG –> 92.41 Cup with Handle 90.09 buy point

Seasonal Stocks
CRMD –> 7.87 See upside of 70% by March 2021 with a 89% probability over the last 12 Years
FBIO –> 3.43 See upside of 53% by March 2021 with a 88% probability over the last 12 Years
NFLX–> 513.97 See upside of 36% by March 2021 with a 91% probability over the last 12 Years
SWKS–> 151.21 See upside of 27% by March 2021 with a 91% probability over the last 12 Years
DPZ –> 396.73 See upside of 21% by March 2021 with a 91% probability over the last 12 Years
NXPI–> 157.33 See upside of 25% by March 2021 with a 89% probability over the last 12 Years
LNG –> 57.90 See upside of 27% by March 2021 with a 82% probability over the last 12 Years
TGTX –> 53.34 See upside of 91% by March 2021 with a 83% probability over the last 13 Years (very risky)