Every January around this time, the financial “experts” roll out their predictions for the year ahead.
Unfortunately, most of them fall short.
After all, it’s incredibly difficult to predict what might actually happen in the economy over an entire year with any degree of certainty. But it’s next to impossible to predict exactly how the markets might react to any of those potential events in advance.
Just think back to this time last year…
Do you remember anyone predicting the level of unprecedented global health and economic turmoil that COVID-19 would unleash over the next 12 months?
I certainly don’t.
But even if someone had foreseen exactly what was coming — widespread shutdowns, unemployment at Great Depression levels, and more than 400,000 Americans dead – they probably wouldn’t have also predicted that stocks would close the year at new record highs.
Still, I think it can be a useful exercise to take a “big picture” look at the economy and the markets, to make some educated guesses about what we might expect in the year ahead.
So that’s what I’d like to do today…
As you’ll see, I believe it’s possible stocks will hit much higher highs in 2021. And there’s potentially a lot of money to be made as they do.
But first things first… Please do NOT let yourself do what we typically do as human beings: Take on too much risk and wind up selling at lows and buying at highs.
Just think back to March 2020 — were you prepared?
Were you able to successfully “sell high” when the crash began and your stops were hit… and then “buy low” when stocks bottomed and started to rise again?
Or did you sell at the bottom in March and not buy back in until much later in the year, missing out on one of the best rallies we’ve ever seen?
If it was the latter, I hope you’ll join me in making discipline a priority in your investing this year. Because I think it’s going to be more important than ever in 2021.
Let’s start with the economy. Right now, it’s all about “easy money.”
Now, it’s true the Federal Reserve has been stimulating the U.S. economy with super-low interest rates and so-called “Quantitative Easing” (or “QE”) for the better part of 11 years now. Easy money policies are nothing new.
But last year, the Fed kicked its monetary stimulus into overdrive in response to COVID-19. And the U.S. government joined in with its own fiscal stimulus in the form of trillions of dollars of direct payments to companies and individual citizens alike.
With the Democratic Party now in control of both the White House and Congress, it’s a solid bet that much more stimulus is on the way. This should continue to be a strong bullish tailwind for the market like it has for the past several years.
Meanwhile, thanks to the unusual combination of hefty stimulus payments, forced savings due to lockdowns, and the ability for many folks to work from home, the average American is in surprisingly good financial health today.
For example, according to data from the St. Louis Federal Reserve, Americans as a whole brought in more income last year (including stimulus payments and unemployment benefits) than any previous year in history… are saving the highest percentage of their incomes in at least 50 years… and are now carrying less overall credit card debt than they were in 2007.
Once we achieve herd immunity against COVID-19 and can fully open back up, the economy could absolutely BOOM.
Given all this, I wouldn’t be surprised to see stocks greatly exceed their 2020 highs this year.
I also suspect the housing market will continue to do well.
Like stocks, housing has gotten a huge boost from the Fed’s easy-money policies. And while home prices in many parts of the country have exceeded their previous “bubble” highs, they probably aren’t done rising yet.
I thought we were in a bubble last May, when I sold my house in just hours with six offers.
In fact, I was positive we were not only in a bubble, but that the bubble would burst in the summer as people “got out” of their homes.
But I was dead wrong. And I no longer think we’re in a bubble in housing today.
Thanks to the “work from home” revolution, many folks no longer need to live near their workplaces. Suddenly, they’re free to live anywhere they choose.
Now more than ever, people want to love their homes and be the most comfortable ever. And they’re willing to pay more to do so.
I think this trend will continue, so long as interest rates remain relatively low.
That said, not everything is rosy today.
While the average American is doing well in the post-COVID world, the divide between the “haves” and “have nots” has grown bigger than ever.
Many folks who are able to work from home have benefited from stimulus payments and loan deferments while collecting their usual salaries.
However, many of those who aren’t able to work remotely — primarily those with lower-paying service jobs and small-business owners — remain unemployed nearly one year later.
When you look at it this way, the economy probably isn’t as strong as it appears.
And while I think it’s a great time to buy (or refinance) a home, I would urge you to be vigilant if you’re looking to make a large investment in real estate right now. I don’t expect another crash anytime soon. But prices have really ballooned over the last year, and I wouldn’t be surprised to see them cool off as rates eventually rise.
There are some reasons to be cautious about stocks today, too.
By some important valuation measures, the broad market is more expensive than it’s ever been before.
And most concerning, we’re now beginning to see the kind of excessive speculation and risk-taking among investors that can lead to trouble.
In particular, A LOT of money flowed into the markets from first-time investors in 2020. Many of these folks are simply gambling on stocks and options via the free trading app Robinhood and have no idea what they’re doing.
They’ve been winning so far, but few have ever experienced a real market correction. They could get crushed and panic when the market pulls back, and this could cause a lot of money to flow out of popular stocks.
Again, I think the government’s unprecedented stimulus is likely to keep markets moving higher this year.
But while I think we could see significant new highs in 2021, that doesn’t mean it will be easy for investors. It could be a very bumpy ride along the way.
I expect lots of volatility, some sharp corrections, and maybe even a crash followed by higher highs.
So, as I mentioned before, if you’re planning to stay invested in stocks this year, you must manage your risk. This is NOT the time to be complacent.
The first and most important way to protect yourself is to have a clear exit plan for every position in your portfolio. You should know exactly when and why you’ll sell every stock and fund you own.
At TradeSmith, we’re partial to trailing stops.
If you’re not familiar, a trailing stop is simply a “stop” (or sell) price set at a specific percentage below the current price of an investment.
As the price of that investment rises, the stop price also rises with it. But if the price falls, the stop price stays the same.
If or when the price of that investment closes below the trailing stop price, you sell that investment and wait for signs of a new uptrend before getting back in.
Our proprietary TradeSmith software makes using trailing stops as easy as clicking a few buttons on your keyboard. It shows you the ideal trailing stop to use for each investment you own. And it automatically tracks them for you and alerts you when it’s time to sell.
But don’t worry if you’re not a TradeSmith subscriber. You don’t have to use our software to use and benefit from trailing stops.
As I told you when we launched this letter earlier this month, I’m not here to sell our software. But I am here to help you take less risk and gain higher rewards.
Our research shows choosing a simple percentage trailing stop of around 25% (or up to 40% for smaller, more volatile positions) can dramatically reduce your overall risk and increase your long-term returns.
So, if you’re not already using trailing stops on your investments, I urge you to give them a try right now.