Market Mailbag: What Dangers Lurk Around the Corner?

Stocks have been going straight up since last Spring – what would cause them to shift course? What is the biggest risk facing the market right now?

Answered by Michael Antonelli, Private Wealth Management Market Strategist

Let me begin by saying that I am bullish on both the stock market and the economy in 2021. As we continue to vaccinate people and economies are reopened, I want to be a part of the economic revival that should accelerate in the second half of this year. To be clear: I am by no means a bear on stocks.

The primary concern I have is that something causes the Federal Reserve to shift their stance away from easy monetary policy. This to me is the most important thing to watch.

Let’s be frank: There is nothing stocks like more than the Fed being committed to low interest rates and quantitative easing. All that money supply has to find a place to go, and it usually ends up in financial assets.

If we hear a Fed governor or committee member start to talk about changing that stance, then that in my opinion would present a headwind to the market. The carnage we saw at the end of 2018 was because the Fed was hiking and tightening monetary policy – let’s be on the lookout for a similar situation here.

Thankfully, the Fed continues to reiterate its commitment to easy monetary policy because, like we learned in 2008–2009, you don’t want to take the patient off of life support too early. You’d rather focus on getting them back on their feet before removing extraordinary aid. This “risk” doesn’t seem imminent to me.

Fed policy is what I’m watching – now let’s hear what my friend Ross has to say.

Answered by Ross Mayfield, Investment Strategy Analyst

To discuss stock market risks, we first need to define what “risk” really means. For long-term investors, short-term market gyrations shouldn’t be a worry – bouts of volatility are just the cost to participate in the stock market’s long-term gains (and are often great buying opportunities to boot). The greatest risk to the long-term investor – panic-selling during moments of fear – often occurs during market selloffs or major news events. So it’s always worth evaluating the potential catalysts for a downturn – to be both mentally prepared for volatility and opportunistic if possible.

So what’s the key risk to the stock market right now? Anything that inhibits a large-scale economic reopening in 2021. Long-term vaccine rollout issues, broader-than-expected vaccine skepticism, a more-cautious-than-expected consumer and the mutation of a vaccine-resistant coronavirus variant (the worst-case scenario) are concerns. Some of these are related – for example, the longer the vaccine rollout takes on a global level, the more likely a vaccine-resistant variant becomes. The promise of widespread vaccination and broad-based reopening has underpinned a lot of the recent market activity (bullish sentiment, cyclical/value rotation, historic stock fund inflows, etc.), so any trip-up here is a risk, even if these events likely have a bigger effect on the real economy than the stock market (like we saw in 2020).

The good news is that we’ve seen this story before. Last year, substantial doses of stimulus, a “Big Tech”-heavy stock market and rapid vaccine progress kept the COVID-19 recession short and the bear market even shorter. But while a vaccine-resistant coronavirus may not cause the same level of panic we saw last March, a significant setback to the economic reopening would likely ding the stock market, particularly given how optimistic sentiment is right now. With a strong reopening priced into a market near all-time highs, any major inhibitor would be a pain, particularly to the areas that have been the best performers over the last few months: Value, cyclical, international and small-cap stocks. It may not be likely, but we’re keeping an eye on it nonetheless.

If you have additional questions on how the market might influence your portfolio and broader plans, your Baird Financial Advisor is here to help. Click here for a Baird Financial Advisor near you.