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Biggest risks to the market in 2021

Yahoo Finance’s Julie Hyman, Myles Udland, Brian Sozzi, and Emily McCormick discuss Wall Street’s worst-case scenario for stocks in 2021.

Video Transcript

JULIE HYMAN: But we're going to start here on the outlook for 2021. Of course, stocks are on track to close this year with double digit gains, traders shaking off the turmoil that we have seen this year. But what are some of the top risks that they are looking for, going into 2021? Emily McCormick is joining us now. Emily, we've seen a lot of bullishness, certainly, heading into 2021. But what are some of the risks to be aware of?

EMILY MCCORMICK: That's right, Julie. Definitely a lot of optimism on Wall Street heading into 2021. But of course, there are still some risks that strategists have been highlighting. So I took a look at a dozen 2021 equity outlooks from strategists, and three key risks really kept coming up as possible obstacles to next year, and potentially another year of double digit returns based on many of their base case scenarios.

Now the first risk is around the vaccine rollout. Now, just taking a look here at the S&P 500 performance since November 9-- that's the day that Pfizer and BioNTech really first announced that very upbeat vaccine efficacy data-- the stocks have already risen more than 5% since that date. There are some concerns here that perhaps the vaccine optimism is already priced in, so it does leave some potential downside risk here in the event of any hiccups in that roll out. So that could be things like issues with distribution, with not having enough vaccines to actually confer herd immunity to Americans as a whole, on the whole of the population. So that is one of the large risks for next year, and one of the obvious ones that investors will be watching.

Now, the second one is actually around Washington, and that has to do with the outcome of the Senate runoffs in Georgia. Now, most of these strategists had priced in the outcome of a divided government heading into 2021. They assume that that will be the outcome after these January runoffs, but that is something that does still hang in balance. As we look at the polls over the past couple of weeks, that spread really-- and the advantage that Republican incumbents have had-- really is starting to narrow here. So that could be something that is also a downside risk to stocks and could potentially trigger a knee jerk downside reaction in the event that Democratic lawmakers do come out with having a majority in the Senate chamber at the end of that election.

Of course, at the same time, there is some possibility that a larger-- another stimulus package could be passed in the event of that, so that could take off some of the risk there. But again, potentially a knee jerk reaction around that.

And then third of all, there are some risks around firming rates next year. Of course, we know that the 10 year yield in treasuries as a whole have really been under pressure this year. Some concerns about liquidity tapering, as JP Morgan strategists have put it, and the possibility that the Federal Reserve may start to signal that they'll be rolling back some of their crisis era facilities and some of the monetary policy that had been so highly accommodative during the coronavirus pandemic. So any signaling of that, possibly in the second half of next year, will be something that traders will want to watch, Julie.

MYLES UDLAND: So Emily, we're talking about the risks that exist out there in the outlook, but I know a note that you're looking at that caught my attention as well, Savita Subramanian over at B of A, relatively cautious compared to a lot of her peers, looking out to next year. And I know B of A tends to do the upside base case and downside scenario, and not great on the downside there.

EMILY MCCORMICK: That's right, Myles. Actually, with the downside case for Bank of America, they actually predict that stocks could potentially actually see a negative return next year. So that's something that we don't necessarily want to see. But their base case is still for 3,800. That implies upside of about 2% from the S&P 500's recent closing high of 3,722 from last week. Still, that would be quite a step down from the 14% rise the index is tracking towards for this year.

By comparison, of course, that median forecast from those dozen strategists is 4,150. So quite a step down from that as well. But really, Bank of America's outlook is based on the fact that they do believe that the recovery is intact, and the world will reopen in the second half of next year. But they fear that a lot of the optimism is already priced in around the vaccine and the recovery in the economy and corporate profits.

They mention, quote, a simple move in the equity risk premium back to the prior decade average of about 500 to 550 BPs versus the current 437 BPs would drive the S&P 500 down to as low as 3,000 or 3,050. So some possible risks, here but overall, that base case still does imply a positive return for next year, Myles and Julie.

JULIE HYMAN: Which does seem to be the consensus, doesn't it? Emily, thank you so much. Always good to keep an eye out for some of the risks in the market.