The markets in 2021 – Why the crazy upward march in stock prices

IN A FAST-CHANGING world, the investment bankers of Wall Street and the City of London have clung to certain rituals. One of these is the annual “outlook”, which lays out the path the economy and financial markets might take over the coming year. These hefty documents start to appear in inboxes a few weeks before the year’s end.

In mid-November a strategist at one bank had just put his outlook to bed with satisfaction. His call on stocks for 2021 was “constructive”: Wall-Street-speak for “bullish, but not mindlessly so”. But a few days later he was feeling a little less pleased with himself. His outlook was not distinctive. Rival strategists too were constructive.

It is not hard to see why. An end to the covid-19 pandemic is in sight. Rich-world governments are rediscovering the joys of fiscal pump-priming. Real interest rates are so low as to make sky-high stocks look cheap (see Buttonwood). In short, the conditions seem ripe for further stockmarket gains. So ripe, indeed, that a persistent thought keeps surfacing in the minds of strategists. What is to stop stock prices worldwide going on a really crazy run?

Several things could get in the way of a market melt-up. One is the economy. Since April markets have been looking beyond the damage from covid-19 to the post-pandemic recovery. The discovery of workable vaccines seemed to bring that world closer. Economic indicators for America and China towards the end of 2020 were surprisingly strong. But the pandemic is not going quietly. More virulent strains of covid-19 have forced stricter lockdowns in parts of Europe. The harm to the world economy is likely to be more prolonged than hoped.

Another obstacle is bullish sentiment. The last time fund mangers were this optimistic about the scope for stockmarket gains was January 2018, according to a monthly survey by Bank of America done in December. A large majority think the world economy is in the “early-cycle” phase (ie, that there is a long runway of growth ahead). Paradoxically, positive sentiment is often seen as a reason to be wary, and that investors have got ahead of themselves. Indeed, 2018 began with much talk of a market melt-up, but ended with heavy stockmarket losses.

A lot of the current optimism rests on the idea that policy will continue to support the economy. What if policymakers change tack? Continued fiscal support requires political action and agreement, which cannot always be relied upon. A natural concern is that stimulus might be withdrawn abruptly, as it was after 2010. So far, though, there is little sign of this. In America the $900bn fiscal package passed after Christmas will add two percentage points to GDP growth in 2021, reckon economists at JPMorgan Chase, a bank. The loss of the Republican majority in the Senate may open the door to further fiscal easing. In Europe the boost from the €750bn ($920bn) recovery fund should start to be felt from the middle of the year.

Yet another risk, and one…