Over the Thanksgiving holiday, I’d be willing to venture that many dinner conversations included ‘investing in vaccine stocks,’ or perhaps some chatter about Tesla’s meteoric rise and inclusion into the S&P 500. Others may have discussed the flashy Airbnb and DoorDash initial public offerings (IPOs) that just took place, with some of the younger folks gloating about their new Robinhood trading accounts.

My point here is that I’m sensing a growing enthusiasm not for investing, but for trading. The two are different. I see investing as a long-term endeavor, executed in a research intensive and risk-controlled manner consistent with a person’s long-term goals. Trading is what people do in an effort to make fast money, with decisions often based more on hype (vaccines, bitcoin, IPOs) than on research.

When Airbnb and DoorDash went public last week, both stocks were massively oversubscribed, in what appeared to be major buy-in from the retail trading community. Airbnb opened on Thursday at $146/share, more than double its $68 IPO price and marking one of the biggest opening day rallies ever. This gave the company a valuation over $100 billion, even though for first nine months of 2020 it posted a net loss of $697 million on $2.5 billion in revenues.1 Paying a premium for future growth is what investing is all about – but where’s the limit?

There are a few sentiment models out there – most notably the Citigroup Panic/Euphoria Model – flashing signs of market optimism and euphoria. The American Association of Individual Investors (AAII) found in its most recent December survey that 48.1% of investors identified as being bullish, which is well above the historical average of 38%.2 In short, there is growing evidence that investors are becoming more optimistic and confident, which in my view tends to make the market more vulnerable to selling pressure. Seeing as there has not been a correction of -10% or more since the March lows, I think we’re due for one soon.

Indeed, upside volatility tends to invite downside volatility, particularly in areas of the market that performed the best off the bottom (so far in this cycle that’s growth and Technology). I’m seeing a classic tenet of stock market investing playing out now – just as investors get comfortable with a rally, the equity market finds a way to deliver a reality check. The market never fails to test investor patience, and I think we should expect a sharp pullback in the first half of 2021 to weed-out some of this newfound enthusiasm and optimism.

If a correction does in fact happen next year, it should not come as a surprise. If you look at the S&P 500 over the last 40 years (1980-2020), you’ll find that not only are corrections frequent, they’re the norm. The average intra-year correction for the S&P 500 since 1980 is -13.8%! In fact, it’s very rare to get a year where the S&P 500 doesn’t fall at least -5% at some point within the twelve-month period. It’s only happened twice in the last 38 years (1995 and 2017), when the S&P 500 declined just -3% intra-year. 3

In 2021, I think we’re going to see a correction more in-tune with the longer-term average, and I think it would be wise for investors to brace for it. Having a diversified portfolio is a good place to start. I think a correction and a subsequent bounce-back could generally favor some of the underperforming sectors and styles in the equity markets, with capital rotating from high valuation names to low valuation names. At Zacks Investment Management, I think our All-Cap Core Strategy could be well-suited for the volatility and rotations I expect next year. We buy stocks with improving fundamentals and sell stocks with deteriorating fundamentals, with no particular allegiance to growth or value or any style. In past years, All-Cap Core has been successful at limiting downside capture, which I think could be valuable to investors in 2021.
Bottom Line for Investors

There’s an old Wall Street adage that investors should “buy the rumor and sell the news.” In the realm of the vaccine, this adage may have already played out – investors rushed into stocks on news of the vaccine’s development and approval, and they may end up selling when the vaccine is actually distributed. I think the “sell the news” side of the equation will land in the first half of 2021.

At the end of the day, however, an investor with a well-diversified portfolio aligned with their goals should not have much to worry about. A sell-off may provide a strategic opportunity to rebalance your portfolio, or if your asset allocation needs adjusting based on a change to your long-term goals or needs, a correction may be a good time to consider implementing it. Otherwise, I think it is good to mentally prepare for a correction, so you can avoid any knee-jerk reactions when it arrives.

Disclosure

1 New York Times. December 11, 2020. https://www.nytimes.com/2020/12/11/business/dealbook/airbnb-ipo-chesky.html

2 AAII. December 10, 2020. https://www.aaii.com/sentimentsurvey

3 J. P. Morgan. November 30, 2020. https://am.jpmorgan.com/us/en/asset-management/gim/adv/insights/guide-to-the-markets/viewer

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