Wall Street strategists see stocks gaining 9% in 2021 after a possible speed bump to start the year

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The stock market appears set on rising into 2021 — a year expected to see some return to normalcy, above trend economic growth, and a higher stock market, according to Wall Street.

Even with this year’s sharp sell-off, the S&P 500 is notching a near 15% gain for 2020. For 2021, many strategists expect another year of double digit gains.

Those in CNBC’s survey expect an average 2021 year-end target 4,056, or about a 9.5% gain from current levels. But some strategists, like Fundstrat’s Tom lee, expect a rally more in line with 2020. Lee sees a surge in the S&P to 4,300 from its current level near 3,700.

Vaccines are expected to liberate individuals from pandemic restrictions and in turn, liberate the economy as 2021 progresses. Work from home should shift back to work at the office; movies will be shown in theaters; diners will eat inside restaurants, and large numbers of people may no longer be afraid to fly or travel.

But the road to that second half scenario is not without bumps. As the virus spreads and hospitalizations are at a record, the economy is showing signs of slowing. The labor market is weakening and weekly unemployment claims have surged to September levels, as restaurants and other businesses shut down or cutback because of he virus.

“The shutdowns are going to be very targeted. It’s nothing like what you saw in the spring,” said Ethan Harris, head of global economics research at Bank of America. “It’s going to eat away at the economy in the next few months. You come in with this big loss of momentum to start the year off. Then you look out to the spring and there are … reasons for optimism.”

Paralleling that view of the economy is the expectation among stock strategists that the market could hit a rough patch early in the year before heading higher.

The week ahead

Stocks in the past week were higher, with the S&P 500 up 1% near ra ecord high in Friday trading. Heading into the holiday shortened Christmas week, traders will be watching the shakeout from the massive S&P 500 rebalancing that came with Tesla’s entry to the index. Tesla first trades as a part of the S&P Monday morning.

“We’ll see whether or not there’s selling of Tesla after the fact. Investors had to buy Tesla coming in, so we may see selling of Tesla once it’s absorbed within the S&P,” said Quincy Krosby, chief market strategist at Prudential Financial. Index investors and funds that own the entire S&P 500 would reduce holdings of other stocks to make room for Tesla.

Krosby said stocks should tilt higher into the year end, unless Congress fails to come up with a stimulus package or there are any surprise setbacks for the Covid vaccines. “At this point, the vaccines are stimulus,” she said.

Strategists expect a relatively quiet week for stocks, and the bond market is also expected to be subdued, as investors finish up year end trades, following last Wednesday’s Fed meeting. There is housing data Tuesday and Wednesday, and jobless claims and durable goods Thursday.

Then of course, there is the focus on the new year.

First quarter speed bump

“The first quarter is typically the toughest from a GDP perspective,” said Michael Arone, chief investment strategist at State Street Global Advisors. He said the earnings season will begin and there’s the potential for some negative outlooks. “I think we’re due for a correction at some point in the first quarter.” Arone said he expects a 5% to 10% pullback, and he says the stock market may have pulled forward some of its gains in 2020.

Fundstrat’s Tom Lee, who was one of the first to call the March rebound, says he’s looking for a 10% correction between February and April, before the market recovers and surges higher.

There is a major wild card looming for the market in the early days of the new year. Polls show the Jan. 5 Georgia Senate elections are very close and have the potential to shift control of the Senate. Political strategists say it’s more likely the GOP will retain control, winning one or two sets, but if there is a surprise upset by Democrats, it could shift the political agenda dramatically.

If Democrats win, each party would have 50 Senate seats, and Vice President-elect Kamala Harris would cast any tie-breaker votes.

“The January 5th runoff in Georgia is an important event for the market, and right now it’s close. It’s important because of the consequences. The expectations are if the Democrats win, the market will sell off,” said Krosby.

But that could be a short-lived reaction since the market would also see the potential for a bigger stimulus package from Democrats.

“But I think as the fiscal stimulus rolls out, and it’s pretty clear you’re going to be at the high end of the range, I think the market will like that. Everyone always talks about how the markets don’t like a progressive agenda, but they do like fiscal stimulus,” said Harris.

Whether it gets a lot of stimulus or not so much, the economy is still expected to rebound.

In an environment where the economy is recovering and central bank policy is easy, strategists expect cyclical stocks will do well as the market looks forward to the second half of the year. By then, many millions should be vaccinated and the economy should be growing.

“Given the fiscal and monetary policy, low rates and eventual end of the pandemic, it’s hard to call for something terrible happening at least from a market perspective,” said Arone.

Arone said investors still need to hold stocks with strong organic growth rates as well as cyclical names that will do better in a recovery. Lee said he favors industrials, energy and discretionary sectors for 2021, but he also still likes big tech with strong earnings, like Apple and Alphabet. He expects a shakeout in some of the stay-at-home stocks, particularly those that don’t have solid earnings streams.

The virus will continue to drive the economy over the next year, but the difference in 2021 is that vaccines are expected to be distributed to the point where they could favorably impact the economy starting in the second quarter. Harris said the economy will get a boost once hospitalizations and the death rate fall from high levels.

He expects first quarter growth will come in at about 1% but by the second quarter, growth should bounce to 7%.

In the CNBC/Moody’s Analytics survey of economists, forecasts for 2021 growth average 4.4%, after an expected decline of 3.5% this year.

If Congress approves a stimulus package this year and another next year, that should give a substantial boost to the economy. Harris said stimulus of $500 billion to $1 trillion is equal to about 2.5% to 4.5% of GDP.

“If you put stimulus like that into the economy that’s open, that’s a big boost,” Harris said.

Economists are looking forward to a period in 2021 where the recovering economy could boost inflation above the Fed’s 2% target, but it is not expected to stay at that level. But even so, strategists look to cyclical names in energy and materials to do well in that environment. Bank of America strategists have already identified a group of stocks that do well in an inflationary period that are outperforming some of those that don’t.