S&P 500 to hit 3900 by Dec’21, Nasdaq may gain like 2020, but Morgan Stanley sounds caution too

US stock market indices S&P 500 and the tech-heavy Nasdaq Composite ended at record high levels in 2020. During the year in February and March, US stock markets got trapped into a bear market due to heavy sell-off on the back of COVID-19 pandemic. According to Lisa Shalett, Chief Investment Officer, Morgan Stanley Wealth Management, market gains could run well ahead of fundamentals in 2021 creating risks for investors. Even as the rollout of the new COVID-19 vaccine has sparked hope among investors, the distribution in the country has been slower than expected.

Morgan Stanley’s cautious outlook

Both S&P 500 and Nasdaq indices posted double-digit percentage gains in the previous year, and may do so again this new year 2021. But Morgan Stanley’s view is measured. While it predicts that the S&P 500, now at about 3750, could hit 3900 by the end of 2021, it has cited a few reasons for cautious outlook on the US stock indices. Morgan Stanley noted that while many investors may ignore high valuations for the time being, the 3900 price target for S&P 500 factors in its estimate for 27 per cent earnings growth this year, which is a very fast rate historically. “Based on a forward price/earnings ratio of 22.4, the S&P 500 is already in the top 10% for valuation in the last 80 years,” Lisa Shalett said in a note.

She also said that the Shiller Cyclically Adjusted Price/Earnings Ratio, which measures price divided by average earnings over 10 years, adjusted for inflation, has only been this high twice in the past 100 years, first in 1929 and second time in 1999-2000. These both occasions were marked by significant liquidity and economic growth well ahead of real interest rates, which is similar to today. This led to steep stock-market declines.

Morgan Stanley in its report noted that factors such as higher long-term interest rates, inflation and a much weaker dollar could destabilize the broader US market. Lisa Shalett suggests investors focus their New Year portfolio actions on security selection, with an eye toward value, dividend income and shorter duration fixed-income securities. Shalett also advised to add assets with low interest-rate sensitivity, inverse correlation to the dollar and inflation protection.