After a turbulent 2020, I'm positive about 2021's outlook for stocks and real estate. We should see significant GDP growth (3-5%), a strong rebound in corporate earnings (20%+), and a massive unleashing of spending (saving rate back down to ~6%). As a result, there's a high probability we will see new record highs in many major asset classes.
What's concerning me is that the majority of us probably think 2021 is going to be better than 2020. Therefore, it may be hard to find the incremental buyer.
However, the great thing about asset bubbles is that they tend to inflate far past reasonable fundamentals. Therefore, even if you know things are ludicrously expensive, it's worth hanging on for as long as possible.
2021 may be one of the greatest times to get rich. Let me share my 2021 outlook for stocks, real estate, and the economy. My beliefs will shape how I invest my money and spend my time.
Financial Samurai 2021 Outlook
I'm going to focus on stocks, bonds, and real estate because that's where most of my assets are (~70%). I'm assuming these asset classes make up the majority of your investments as well. You are free to speculate all you want in Bitcoin and other asset classes. However, my focus is on building wealth with the majority of my assets.
10-year Bond Yield
Everything starts with the risk-free rate of return. Once you've made a proper forecast of the 10-year bond yield, you can then proceed to make your appropriate investments.
If you've been reading Financial Samurai since 2009, you know that I've consistently believed the 10-year bond yield would stay low or keep going lower. America has contained inflation. We've learned from many previous economic cycles. We have globalization. Technology makes information flow instantly. Federal Reserves are coordinated.
I believe the 10-year bond yield will increase in 2021 back up to 1.25% by 2H2021. In other words, the yield curve will steepen and banks will be one of the better investments.
To put things in perspective, 1.25% on the 10-year is still 70% lower than where it was in 2018. However, as of March 12, 2021, the 10-year bond yield is now at 1.5%. Therefore, my 1.25% average for the year is looking tenuous.
I don't believe the 10-year bond yield will surpass 2%. Once we take a step-function down in rates, it's hard to move back up due to expectations. I also believe the aggregate bond market will have a flat year.
With interest rates inching up, the aggregate bond market index will likely have a flat year. I envision a scenario where bond yields make up for the decline in principal values.
Everybody who is considering refinancing should refinance now while rates are still near all-time lows. Check out Credible for some real, no-obligation quotes. Multiple qualified lenders will compete for your business.
Now that I've established a view on the risk-free rate of return, let's move onto my S&P 500 and real estate outlook.
S&P 500 Outlook 2021
The first part of making an S&P 500 forecast is making a decision on whether the index will go up or down. The second part is estimating the magnitude of growth or decline through GDP and earnings forecasts.
My S&P 500 bottom call in 2020 was spot on. However, my estimate on the amount of the recovery was not. I didn't expect us to rebound as much. As a result, I did not buy enough on the way up.
For 2021, I expect the S&P 500 to increase by 8% in 2021 for a year-end target price of 4,088. If the S&P 500 can generate an EPS of $165, that puts valuation at 25X. If the S&P 500 can generate a $170 EPS, then its P/E drops to a more reasonable 24X for 2021.
A $165 – $170 EPS is equivalent to a 25% – 30% increase over 2020 estimated earnings (still waiting for 4Q2020). Therefore, from a price-to-earnings-growth metric, a 25X multiple is reasonable.
Consensus S&P 500 EPS estimates are for $190 in 2022. But the S&P 500 will only start trading on 2022 earnings beginning in 3Q2021.
2021 Valuations Are Expensive
To put a 25X earnings multiple in perspective, check out the chart below. 25X puts the S&P 500 at a 20-year high. And achieving a 25X multiple is predicated on experiencing a 25% earnings rebound in 2021. If earnings don't come through, the S&P 500 will most likely be flat or decline.
However, it's worth noting that 90% of the S&P 500's market capitalization is now based on intangible assets such as R&D, IP, and software. Therefore, one could argue there should be a natural rise in valuations for companies that have higher operating profit margins and more defensible income streams.
Partly based on expensive valuations, investors should expect corrections of 5-10%, multiple times in 2021. Therefore, you may want to wait for these corrections to put new cash to work.
Wall Street S&P 500 Forecasts 2021
Wall Street is very bullish on the S&P 500. A couple of the biggest bulls are Goldman Sachs and JP Morgan, who have year-end 2021 S&P 500 target prices of 4,300 and 4,400, respectively. JP Morgan has a 2021 EPS estimate of $178 for a 36% rebound in earnings.
I sincerely wish Goldman and JP Morgan are correct. Their analysts and strategists surely make enough money.
However, I believe their forecasts are too high. Like children eagerly anticipating receiving every present on their wish list before Christmas, I fear they will be disappointed with only one or two presents.
We have three risk factors to corporate earnings:
- Virus mutations that lower current efficacy rates of existing vaccines.
- Much slower-than-expected vaccine rollout, delaying 2021's expected economic recovery into 2022.
- The Senate going blue, which breaks a lot of gridlock. More regulation and higher taxes should slow growth at the margin. Then again, we could see even stimulus package going forward.
Forecasting a 30% – 40% rebound in earnings growth to justify an S&P 500 level above 4,200 is too aggressive.
Money should flow into Consumer Discretionary, Financials, and Energy. These are the sectors that lagged the most because they also got hit the most.
I don't think tech investors should expect a similar type of outperformance as the economy rebounds. In fact, I think big tech has a 65% chance of underperforming. The NASDAQ is trading at 40X P/E, the highest since 2014. The index has essentially doubled in two years.
If there are any 1-2% dips, I will be buying the S&P 500. However, I'm not aggressively putting new money to work if the S&P 500 keeps marching higher. There are much better deals to be had in real estate.
Real Estate Outlook 2021
The median home price in America went up about 8% in 2020. That's a 40% gross return on a 20% down payment. This level of growth is unsustainable, especially since mortgage rates are unlikely to go down further.
Despite the strong gains, I believe residential real estate will continue to do well in 2021. I forecast a 5% YoY national median growth rate in 2021, closer to the levels we have seen between 2015 – 2017.
Meanwhile, commercial real estate will start catching up as the economy opens. There should be deals to be had in the hospitality and office space. You want to buy those properties from owners who are over-leveraged and can't hold on until the economy fully reopens.
Mortgage rates won't increase by more than 25 basis points on average e.g. 2.75% on a 30-year fixed to 3%. Investors will smartly shift some of their stock gains to real estate. There will be an increase in appetite for cash flowing rental properties given the value of income has gone way up.
Once you've had huge principal gains, you want to convert some of these gains into a steady income stream. If you follow this strategy of consistently converting some of your capital gains into income-producing assets, you will become a very wealthy person over time.
Where To Buy Real Estate
For 2021, strategically, I like buying real estate where there is the biggest difference in company share price performance and local real estate price performance.
For example, the NASDAQ closed up 42% in 2020. Therefore, you want to buy real estate in places like the San Francisco Bay Area, where many NASDAQ companies are located. The amount of wealth tens of thousands of employees have made in the Bay Area is absurd.
I feel much richer after a 40% 2020 equity performance, and I don't even work in tech. Many of these tech employees have seen far greater returns and will want to rationally diversify their investments.
I believe big-city real estate will make a nice comeback in 2H2021 and 2022. Therefore, you want to strategically buy before the comeback is really evident.
The herd always waits for a green light. In SF, I've witnessed the herd come back by 2003 after the 2000 dotcom crash and by 2012 after the 2008-2009 financial crisis. But this time, everything is recovering more quickly. If you are a renter, you should try and lock in a long-term lease now.
At the same time, I continue to believe in investing in the heartland of America. Not only is there a fanning out within cities to save on living costs. There is a fanning out across the country thanks to technology and the permanent acceptance of working from home. This trend is decades in the making as new great cities emerge across the country.
The easiest ways to invest in the heartland of America is with Fundrise or CrowdStreet. Fundrise has created diversified eREITs and eFunds for exposure. CrowdStreet focuses on individual real estate deals in 18-hour cities for accredited investors.
Both are the leading real estate crowdfunding platforms today. Both are free to sign up and explore. If you're curious, CrowdStreet has shared their commercial real estate outlook for 2021.
Your Goal For Real Estate Investing
In the latter half of 2021, there will likely be more discussion about inflation. Inflation chatter must pick up if the Fed stays accommodative and stocks and real estate continue to do well.
Therefore, you want to at least be neutral inflation by owning your primary residence. This way, you can at least ride the inflation wave while having a nice place to stay. Enjoying your appreciating asset is such a wonderful combo.
But in an inflationary environment, what you should really do is go long real estate by owning more than one property. This way, you can benefit from capital appreciation and rental appreciation. If you own only one property you can't monetize any appreciation unless you can splice the property out or rent out rooms.
Let me give you an anecdote about the potential future of rental properties. During my latest rental lease negotiation, I accepted less rent for hopefully better tenants. However, as part of giving my tenants a discount from my original asking price for the first year, they've agreed to a 4% increase in rent for the second year starting at the end of 2021.
2021 Should Be Profitable
Although most of us are bullish on stocks and real estate in 2021, I still think these two major asset classes will perform well. The Federal Reserve and the Federal Government are accommodative.
If something bad happens in 2021, we can count on Janet Yellen and Joe Biden to bail us out. There's no way they can't since they just got into power. Once you have power, you want to hold onto it at all costs. Of course, with valuations so high, we must expect 5-10% corrections throughout the year.
There is a massive amount of savings that is ready to be unleashed. Take a look at your own balance sheet. Ask your friends and colleagues whether they've got large cash buffers. Chances are high they do because the national savings rate has been elevated since March 2020. This money will go back into the economy.
You may not be able to benefit from the latest round of government stimulus due to income restrictions. However, you can benefit by investing in companies and cities that will be beneficiaries of the stimulus.
I believe there's a 75% chance 2021 will be a great year for stock and real estate investors. Just make sure you don't over-leverage yourself. After all, even if there's a 75% chance of making money, there's still a 25% chance of losing money.
Best Way To Track Your Investments
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Readers, what are your predictions for 2021? What are some big goals you have in mind? Do you believe 2021 will be a great year?
Disclaimer: As always, invest at your own risk. Don't invest in money you cannot afford to lose. Always discuss your investment thesis with others. Run the numbers over and over again. There are no guarantees in investing.
Finally, if you are paying someone to invest your money, don't forget to ask them how they did in 2020 and what their forecasts are for 2021. Have them review your 2020 performance and their 2021 game plan for you. You have the right to an explanation.
Related: 1H 2021 Financial Samurai Review