Markets kicked off the new year by repeatedly testing fresh all-time highs through most of January, before a late-month slump saw the gains evaporate. After notching a handful of record closing highs, the S&P 500 ended January down 1.1%.
There were plenty of political headlines driving volatility—from the Senate run-off elections in Georgia, to the assault on the Capitol, to the inauguration of President Joe Biden. But perhaps the biggest story came from an unexpected source: Extreme speculation in certain corners of the stock market.
While speculative stock manias are nothing new, the disruptive power of day traders reached a fever pitch in January. The market frenzy in shares of video game retailer GameStop was genuinely shocking, with the stock up 1,700% on the month at one point. Fellow YOLO stock, AMC Entertainment Holdings, was up more than 800% on the month at one point. Both stocks only fell slightly from their highs by month’s end.
“I suspect when the time comes, we’ll look back at this period and see how obviously silly some valuations got,” notes Michael Winter, the founder and chief executive officer of Leatherback Asset Management in Palm Beach Gardens, Fla. “But right now, we’re in the punch bowl phase and markets seem bulletproof, while traders feel ebullient and happy.”
These types of speculative runs don’t show any signs of letting up soon, which makes it all the more difficult for people like Winter, who picks stocks based on their fundamentals—like the financial health of the company—for actively managed exchange-traded funds (ETFs).
The focus for the market overall will inevitably return to more typical concerns, like corporate earnings, the pace of the economic recovery, the pandemic and progress on President Biden’s ambitious policy agenda.
Covid Remains the Most Important Factor for Market
February marks the one-year anniversary of the start of the bear market that sent the S&P 500 tumbling nearly 34% in about a month. Even though stocks have fully recovered and kicked off a new bull market, progress and setbacks related to the Covid-19 pandemic continue to be a primary concern for investors.
“The most important thing for our well-being and the economy and capital markets is progress around Covid, both in terms of infections and vaccinations,” says Bill Merz, head of fixed income research at U.S. Bank Wealth Management in Minneapolis. “There is a lot of hope and expectation that the vaccine rollout continues at a rapid pace and vaccine efficacy is what we expect it to be and that, as a result, economic activity will continue to gradually normalize.”
Meanwhile, the economy isn’t exactly roaring back. Gross domestic product (GDP) expanded at a 4% annual rate in the fourth quarter, which was slightly less than economists expected, and the U.S. economy shrunk by 3.5% in 2020, according to advance estimates released in late January by the Bureau of Economic Analysis. An update of these estimates is scheduled for release on Feb. 25.
Based on the hundreds of economic data points that Merz and his colleagues track across the globe, there’s a common theme: “An improving economic picture, albeit gradual,” he says. But another wave of Covid-19 cases or a spike in the death rate could restrict economic activity once again, which means the ongoing pandemic remains “the most important factor” for the market heading into February, he adds.
“Investors are positioning for an economic recovery and so we need to see a continuation of progress in order to maintain that strong sentiment,” Merz says.
Market Could Take a Breather as Washington Sorts Out Policy Goals
Don’t look to the stock market for a real-time indicator of how the rest of the country is doing. Despite the new bull market, more than 10 million Americans are unemployed and struggling financially—and many of them haven’t seen any direct benefits from the rise in stock prices.
The latest figures compiled by the Center on Budget and Policy Priorities illuminate these hardships: 21% of adult renters aren’t caught up on rent, 35% of adults had trouble covering usual household expenses in a recent week and 15% of adults with children in the home lacked sufficient food in a recent week.
In a series of executive orders in his first days in office, President Biden has requested an extension of the freeze on federal student loan payments, expanded food assistance programs, and an extension of eviction and foreclosure moratoriums, among other measures. He also announced his top legislative priority, a $1.9 trillion stimulus package.
These policy initiatives will be a big focus heading into February, especially as there is likely to be “some wrangling” about the exact scope of that proposed package among members of Congress, says David McInnis, a certified financial planner (CFP) and the co-founder of The East Paces Group in Atlanta.”It is my hope and expectation that some version of the stimulus package will get passed in February.”
Still, McInnis says he would like to see a more targeted approach to further stimulus that focuses on industries—like travel and restaurants—that have been hit especially hard by the pandemic. And the recent rally “could take a breather” in the month ahead as the exact details of President Biden’s proposed package are sorted out.
“If Congress is haggling over the price tag, or how the stimulus is priced and deployed, I think that could be an issue for why the market slows down in February,” McInnis says.
Earnings season (for the fourth quarter of 2020) will also continue into February, and that’s typically a volatile period for the market in general. Some companies that have reported profit results in recent weeks that handily beat Wall Street expectations while others have revealed the ongoing toll to their business from the coronavirus pandemic. “We anticipate a little bit of softening in the market in terms of earnings news,” McInnis says.
Finally, February historically isn’t a great one for the market—it’s one of just three months of the year when the S&P 500 has experienced average declines going back to 1929, according to data compiled by Yardeni Research.
The Market Outlook for the Remainder of 2021
It certainly hasn’t been a boring start to the year for investors, but the speculative fervor of January has been pretty contained to certain stocks. For now, there’s no reason to believe that the outlook for the broader market in 2021 will change as a result.
Early in January, as the number of Covid-19 cases spiked, investors overlooked the pandemic to focus on what would happen months down the road. “Markets were looking ahead to a world where the vaccine was available, which allows activity to resume to close to normal again,” Merz says.
The vaccine is also top of mind for the Federal Reserve. Following the Fed’s most recent meeting in January, Chair Jay Powell said the economy is moderating and pledged that the central bank will leave interest rates near zero and continue its quantitative easing program for the foreseeable future. But the Fed’s tools don’t compare to the potential impact of getting Americans vaccinated, according to Powell.
“That is really the main thing about the economy is getting the pandemic under control, getting everyone vaccinated, getting people wearing masks and all that,” Powell said during a news conference on Jan. 27, following the Fed’s policy meeting. “That’s the single most important economic growth policy that we can have.”
Still, Fed policies have played a key role in markets. By keeping bond yields low, money keeps flowing into stocks rather than bonds because of the higher relative returns, McInnis says. The proposed stimulus package would inject more money into the economy, which could further boost stock prices. “We anticipate a solid year for stocks,” he adds.
Finally, even though there still is so much uncertainty about the near-term future, Merz says the longer-term prospects for investors are more favorable.
“We do have a glass-half-full outlook,” he says. “We have a slight preference for holding larger-than-usual positions in stocks and slightly less than normal positions in bonds to capture the potential for additional upside.”