In 25 days, one of the wildest years on record for the stock market will come to a close. In no particular order, the investing community has witnessed:
- The fastest bear market decline of at least 30% in history.
- The quickest rebound from a bear market bottom to new highs of all time.
- The highest reading ever recorded for the CBOE Volatility Index.
- A brief period where West Texas Intermediate crude oil futures traded deeply in the negative.
And yet, despite all of the disruptions and uncertainty caused by the coronavirus disease 2019 (COVID-19) pandemic, the benchmark S&P 500 (^GSPC -0.23%) is on track for a double-digit yearly gain, while the iconic Dow Jones Industrial Average (^DJI -0.31%) may well finish the year above 30,000.
With potentially multiple effective COVID-19 vaccines on the horizon, and the Federal Reserve pledging to keep interest rates at or near historic lows for a minimum of three more years, it would appear that the stars are aligned for equities to thrive in 2021.
But this might not be the case. Here are the five biggest threats to the stock market in 2021.
1. Vaccines fail to halt the pandemic
Arguably the biggest potential perpetrator of a stock market crash in 2021 is the recent savior of the S&P 500 and Dow Jones: Vaccines.
On the bright side, the Pfizer (PFE -0.49%)/BioNTech (BNTX -1.68%) and Moderna (MRNA -0.24%) vaccine candidates blew the expected efficacy number out of the water. Researchers were expecting a vaccine efficacy (VE) similar to what we see with influenza (around 50% to 60%). What Pfizer/BioNTech and Moderna delivered were respective VEs of 95% and 94.5%. On the surface, these figures offer a real chance to halt the pandemic.
The issue is that we don't know some very pertinent information about these vaccine candidates. In particular, we don't know how long these vaccinations provide protection, nor do we know if taking the vaccine ensures that a patient can't spread the illness to others. These are questions that will be answered over time, and it might signal Wall Street's premature victory over COVID-19.
2. Not enough people choose to get the vaccine
To build on the first point, a vaccine is only as effective as the public's willingness to take it.
Back in May, Pew Research Center surveyed adults to assess their willingness to take a COVID-19 vaccine (if available). Seven month ago, 72% of those polled would "definitely" or "probably" get the vaccine, compared to 27% who would choose not to. In September, Pew asked U.S. adults the same question, but with strikingly different results. This time around only 51% definitely or probably would get the vaccine, with those "definitely" in favor of getting inoculated halving from 42% to 21%. Meanwhile, those "definitely" against getting the vaccine more than doubled from 11% to 24%.
This shift can be explained by the public viewing these vaccines as being rushed through the normal regulatory process. Further, the mortality rate of COVID-19 has fallen since May as we've learned more about the illness and have stepped up testing.
According to Dr. Anthony Fauci, the director of the National Institute for Allergy and Infectious Disease, at least 75% of the population would need to get the vaccine to achieve herd immunity. That's looking unlikely, which leaves the stock market vulnerable to another steep sell-off.
3. The U.S. falls off the stimulus cliff
If lawmakers on Capitol Hill don't act quickly, a lack of fiscal stimulus and protections created during the coronavirus pandemic could cause the U.S. economy to go over a cliff.
There's no question that, for the time being, the U.S. economy is on the mend. Multi-decade highs for the unemployment rate have continued to retrace, while consumption has been on the rise. Consumption accounts for about 70% of U.S. gross domestic product.
The concern is that we're seeing a spike in COVID-19 cases around the country that far exceed the levels observed in the spring or summer. As a result, select states have, again, chosen to impose tighter restrictions to lessen the spread of the SARS-CoV-2 virus that causes COVID-19. These restrictions may lead to job losses and reduced economic activity -- only this time around, there's no stimulus to prop up struggling workers and families.
In a matter of weeks, we could reach a point where renters can no longer pay their landlords, and creditors can no longer pay their debtors. A lack of financial protections provided by Washington, D.C., could hit financial stocks hard and drag the stock market notably lower.
4. Democrats win both Georgia Senate runoffs
There's also a lot riding on the Senate seat runoffs in Georgia.
As things stand now, Republicans have won 50 U.S. Senate seats, compared to the 48 held by Democrats and Independents. If the GOP were to win one of the two remaining runoff seats, which has long been the expectation of Wall Street, they'll hang onto control of the Senate until at least early 2023, with the White House and House of Representatives under Democrat control. A split Congress would make Wall Street very happy, because it would make corporate tax hikes and major policy changes unlikely.
But if both Democratic Party candidates win on Jan. 5, it would essentially create a 50-50 tie in the Senate. Any votes that end in a tie in the Senate are broken by the vice president, which in this case would be Vice President-elect Kamala Harris. In other words, if lawmakers strictly voted along party lines, with Harris providing the tiebreaking vote, we could see corporate tax hikes tax shape under the Biden administration.
According to various Wall Street estimates, increasing the peak marginal corporate tax rate to 28% from 21% would slash earnings by about 10%, and could well send the stock market tumbling.
5. Short-term emotions get the better of investors
A final stock market threat that can't be overlooked in 2021 is our own emotions.
Even if you're a long-term-focused investor, you should know that there are more than enough short-term-oriented traders and emotion-driven investors to move the stock market based on news events. The reason stock market corrections and crashes seem to happen much faster than orderly increases in the S&P 500 and Dow Jones has to do with emotions getting the better of short-term traders and sending them scurrying to the exit.
The data is pretty clear that if you hold onto your investments over the long-term and allow your investment theses to play out, you have a pretty good chance to build your wealth.
Emotions can be a dangerous thing when it comes to investing. Don't be surprised if an overreaction to a short-term event hits the stock market hard in 2021.