2021 Outlook: The Recovery Year (December 14, 2020)

by Bill O’Grady & Mark Keller | PDF


  1. The economy is in recovery, but the expansion phase of the cycle (where economic output exceeds its prior peak) isn’t likely to begin until 2022. We look for weak first quarter growth followed by more notable strength for the remaining three quarters as the COVID-19 vaccines are distributed.
  2. Monetary policy has made a historic shift:
    1. Volcker’s policy of pre-emption to prevent the return of inflation expectations has ended. Thus, policy tightening won’t occur until there is clear evidence of sustainable inflation.
    2. The Fed is actively taking steps to prevent asset runs across the non-bank financial system. This policy will stabilize the financial system at the cost of creating moral hazard.
    3. To address inequality, the Fed will actively try to extend the business cycle.
  3. The liquidity injection into the economy is unprecedented. Determining the flow of this liquidity is the key element to forecasting the economy and asset markets.
  4. Inflation may rise in H2 2021 if vaccine distribution triggers pent-up spending. But we don’t expect a rise to exceed 3% of core PCE and it won’t bring a reversal in monetary policy.  We also don’t expect the rise to be sustained due to the underlying factors dampening inflation.
  5. Our forecast for 2021 S&P 500 earnings is $147.84 with a multiple of 26.5x. The forecast range for the index is 3918-4050.
    1. Given the level of liquidity, there is a substantial likelihood of exceeding this forecast.
    2. We favor small and mid-caps over large caps.
    3. The growth/value ratio is at an extreme, favoring the former. If the economy improves as we expect, a reversal of this ratio is likely, although it may not favor the entire spectrum of value stocks.  Cyclical stocks should perform well.
    4. Our expectation of dollar weakness should support international stocks for dollar-based investors.
  6. In fixed income, we favor investment-grade corporates. High yield appears fully valued and duration risk should be avoided.
  7. Commodities should be supported by better economic growth and a weaker dollar.  Oil prices will likely lag, holding in the low $50s for WTI.  We favor other commodities, and view gold as attractive at current levels.

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