Things look pretty good for individual investors, but now is not the time to get greedy. In fact, there is a high level of greed right now, normally a contrary signal, cautions Brian Kelly, fund expert and editor of MoneyLetter.
There are many factors that may put pressure on our equity markets as we move toward 2021. You should maintain diversification as a way to manage risk as well as participate in the upside potential.
Less political uncertainty and positive news on coronavirus vaccines were the main drivers of the extraordinary month we saw in November (it was the best monthly performance for the Dow in almost 31 years).
Corporate earnings for the third quarter were better than expected, providing important fundamental support to prices. While earnings are down year-over-year by 6.3%, this compares quite favorably to -49% and -33% for the 1st and 2nd quarters of 2020, respectively.
Despite the positive trend in earnings, the forward 12-month p/e ratio for the S&P 500 is 21.7, well above the 5- and 10-year averages. We are not optimistic that earnings will drive prices higher, at least for the first half of 2021.
Don't chase the market. Many analysts — including us — believe that investors are feeling a bit too euphoric right now. It is important you avoid a growing sense of complacency after a feel-good period like we've just seen.
A sobering thought: JP Morgan is forecasting negative growth in the 1st quarter of 2021, and there is a growing discussion in the industry of a double-dip recession. Taking a closer look at this notion, here are five reasons to be circumspect about US and world stocks over the next few months:
1) Technicals are extends. In particular, with the market near all-time highs, greed is taking control of investors. CNN Money's Fear & Greed Reading was recently at 92. That's solidly in the Extreme Greed zone. Fear of missing out — FOMO — is not a sensible investment strategy.
2) The pandemic surge. This new wave is well underway and nobody know just how bad it will become. It is likely to have a profound economic impact, and is the key factor in the double-dip talk. While the vaccine news has been encouraging, it is clear that the logistics of delivery will result in delays.
3) Covid relief is expiring. Several of these programs are set to expire on December 31. Their future is unknown and if only a limited relief bill is ultimately passed, the markets will be disappointed.
4) High unemployment. Recent weeks have trended in the wrong direction, particularly when you include freelance and independent works. Consumer spending could deteriorate if the trend continues.
5) Run-off elections. The markets are pricing in a divided government at this time. If Democrats take the two open George US Senate seats, the unexpected result will jolt the markets. A greater change of tax hikes and increased regulations, coupled with current lofty prices, would increase volatility.
The temptation may be to load up on equities so you don't miss the boat. But our best advice is to not alter your approach. There is enough economic uncertainty domestically — especially with the latest Covid developments — to justify a sizable pullback (say 5% to o10%).
If you've followed our advice throughout 2020, you've made some good money. Now is not the time to be greedy.
