2021 Themes To Watch And Technical Stock Market Outlook
Despite Covid-19 and a slower world economy due the pandemic shock, global equities had a very good 2020. Overcoming declines in the first quarter, stocks rallied back to finish the year strongly. The Vanguard Total World Stock ETF (VT)
Global markets will end December on solid footing. Of the 48 global markets that William O’Neil + Company tracks, 47 are in an Uptrend (33 in a Confirmed Uptrend, 14 in an Uptrend Under Pressure) while just one is in a Downtrend. As seen in the tables below, these positive trends are present in both developed and emerging markets, and this type of breadth is usually indicative of further gains ahead. While the speed and distance of this rally have been remarkable, O’Neil takes its signals from what is currently occurring in the market, so investors should remain bullish until signs of technical weakness emerge.
Much like the global picture, the U.S. equity market’s technical status is bullish. In addition, 2020 was significant given: 1) It ended the third-longest and fourth-highest gains of 21 bull market cycles going back to 1900. That bull market cycle was 5x the median of 114 weeks and gained 3.5x as much as the median 97%. 2) The February-March crash was the shortest bear market of 22 cycles (defined as a 25% or greater drop off highs) going back to 1900. Amazingly, the 2020 bear market was shorter than the crashes of 1929 and 1987. It’s depth of -38% was only slightly less than the historical median of -41%, although the median length is 75 weeks.
Currently, the market is 40 weeks into a new bull market, roughly one-third the median length. However, performance-wise, because of the sharp nature of the recovery, the market is two-thirds of the way to its median gain after a 68% rise from March lows. Using the 120-year history of past market cycles as a guide, despite large gains in 2020, there could be more ahead for this current bull market.
In March, no one could be sure if the market bottom in real time was the final low. After the follow-through day on April 2, defined as a day when the market gains 1.7% or more on volume higher than the previous day at least four days after lows have been established, the new bull market was not officially established (+30% from lows) until early May. This up cycle has continued with few drawdowns since early April.
On a relative basis, the recent underperformance of U.S. large-cap indices has been driven by a pause in mega-cap stocks such as Amazon
Despite the wide return spreads this year favoring the Nasdaq
Given the immediate technical picture, my current view on the U.S. market remains positive, reinforced by a positive historical backdrop. As shown in the charts below, the first year of a U.S. presidency averages a +10% gain for the S&P 500, second-best behind the third year of the presidential cycle. The index posted a positive year in eight of the 12 prior instances, including eight of the past nine. Given the possibility of further government fiscal stimulus early in the Biden administration, at this point in time I am hesitant to bet against historical precedent. I would point out, though, that Q1 does have slightly negative averages.
The strong gains of 2020 suggest further gains in 2021. In the past, following a year of 15%+ gains (the S&P 500 is up 15% this year as of December 29), the next year is positive roughly 70% of the time with an average gain of +7%, approximately in line with overall annual average stock market performance. Against the slightly negative backdrop of Q1 first-term averages, Q1 following a year with a gain of at least 15% is better, up an average of 2%. The table below shows the prior 20 instances of years with gains of at least 15%, along with the performance in the following year and following Q1 (*first year of a presidency).
U.S. Market Breakouts
One proprietary statistic that William O’Neil + Co. tracks is the number of stock breakouts, defined as a stock moving out of a base or period of consolidation on strong volume. Normally, a breakout precedes above average returns for a stock. In July, the U.S. market saw an improvement to an above average number of breakouts, which served as a confirmation of a new bull market. An extended bull run, like that of mid-2016 through early 2018, will see many weeks where the number of breakouts spikes and some brief dips back to below average. This is normal as stocks consolidate and then emerge out of new bases. To keep the trend going, we want to avoid an extended period below the average number of breakouts, which would forecast market weakness and a possible end to the bull market. As seen on the chart below, the number of breakouts greatly increased in October and November of this year. This suggests further positive momentum for U.S. equities.
At O’Neil, timing is crucial in buying and selling stocks. A major tenet is to buy high-quality growth stocks just as they emerge from bases (breakouts) and not to chase stocks as they become too extended from prior base structures. With this in mind, there are several areas of the market that have enjoyed huge recent stretches of performance but should currently be approached with caution. Small-cap growth, for example, rose 34% in Q4 alone to highs this week. It reached as much as 38% above its 200-DMA, the most in its history. Alternative Energy, including ETFs like TAN, QCLN, and ICLN, were up 50‒60% or more in Q4 to recent peaks.
These are each more than 75% above their 200-DMA, the most in their respective histories. Semiconductors (SOXX)
Global ex-U.S. Markets/Breakouts
Similarly, the number of breakouts has also increased overseas, suggesting further price gains are in store. Many of my favored international markets are the same as last year: In the emerging world, I like China, India, South Korea, Taiwan, and Brazil, which are all at or near all-time highs; in the developed world, I favor Japan, which broke to a 30-year high in November. In Europe, I like Finland, Denmark, and Sweden, where a smaller number of strong ideas can impact market indices significantly. Two key markets, the UK. and Hong Kong, are in uptrends but have technical overhangs to work through. The newly signed Brexit trade deal between the UK. and the EU could be a positive, but for now I think it wise to withhold judgement until I see how it plays economically.
Themes I like for 2021 include electronic payments, as the global pandemic has increased the use of non-cash payments; ecommerce/direct-to-consumer Retail, which has been accelerated due to the pandemic; clean energy and electric vehicles, driven by increased governmental enthusiasm in Europe and the U.S.; video gaming, another beneficiary of stay-at-home trends; semiconductors, due to the 5G mobile communications transition as well as the new video game console cycle; and cleaning and testing medical devices and equipment due to the pandemic. As 2021 unfolds and the vaccine rolls out, several re-opening themes should also strengthen, namely travel-related stocks such as hotels, casinos, airlines, and cruises. Also, improving economic performance in emerging economies should help Financial and Capital Equipment stocks in those markets.
Areas I think could be thematically challenged in 2021 include developed market banks, given continued low global interest rates; legacy fossil fuel Energy, given the rapid shift toward and demand for clean climate neutral energy; and mega-cap Technology companies that are the subject of increased regulatory scrutiny and possible governmental antitrust actions.
Kenley Scott, Director, Global Sector Strategist at William O’Neil + Company, an affiliate of O’Neil Global Advisors, made significant contributions to the data compilation, analysis, and writing for this article.
No part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed herein. O’Neil Global Advisors, its affiliates, and/or their respective officers, directors, or employees may have interests, or long or short positions, and may at any time make purchases or sales as a principal or agent of the securities referred to herein.