2020 has been a challenging year due to the coronavirus. There’s been a total of 18 million cases in the US that have resulted in 300,000 deaths. It’s also been devastating for certain industries within the economy, such as entertainment, travel, and restaurants. 

However, hope is on the horizon as vaccines are starting to be distributed to high-risk populations. Yesterday, HHS Secretary Azar commented that 50 million doses should be distributed by the end of January. Based on this pace, the economy could fully reopen and return to normal by the end of Q2. 

Thus, the drag on the economy from the coronavirus should turn into a massive tailwind. There will be pent-up demand for going to movies, eating out, traveling, and various services and experiences that were depressed for more than a year. Meanwhile, other parts of the economy are in remarkably good shape and will continue to be positive contributors to growth.

As a result, I believe that 2021 is going to be a very strong year for the economy. We could see GDP growth between 7 and 10%, unemployment falling below 5%, and new record highs in all sorts of metrics like industrial production, consumer spending, wages, and housing prices. 

This optimism is being reflected in the stock market. Since the beginning of November, it’s been trended higher and even recently reached new all-time highs, despite the near-term COVID-19 situation getting worse. Yesterday, the S&P 500 futures were lower by 2.5% overnight on the news of a mutated, more contagious strain of the coronavirus in Europe. However traders and investors were buyers of this weakness, and the index closed 0.3% lower with even more strength in the Nasdaq and Russell 2000. 

This type of bullish market action in the face of bad news is another indication that markets have priced in these negative factors and is focused on the improving intermediate-term picture.

The Case for a Strong Economy in 2021

Just like the broader economy has its own cycles, so too do various components of the economy. So, some sectors can be expanding, while others are contracting. Entering 2021, we could get the rare circumstance of all these components’ cycles synching up to be expansionary.

Consumer Spending

70% of the US economy is based on consumer spending. Due to the stimulus and lack of job losses for higher-income earners, it’s been strong, even amidst the pandemic.

Further, this strength is confirmed by other metrics.

Household net worth is in the best shape they’ve been in decades. Strength in housing and the stock market also contribute to economic confidence that is also supportive of spending.

Government

Yesterday, Congress passed another $900 billion stimulus package. For years, we’ve had the “Fed put” in which markets believed that any meaningful dip in the market would be met with Fed action. This time, we also have a “fiscal put”.

There is basically no appetite for austerity. Trillion-dollar deficits are the new norm. The 2020 election has shown us that the balance of power in the country has shifted from industrial workers and farmers in the Rust Belt to college-educated swing voters in the suburbs who comprise a meaningful chunk of consumer spending. We will see continual appeals to this group which is also consistent with expansionary fiscal policy.

Housing

The housing market is in great shape. The pandemic led to a surge in demand. The Fed slashing rates also increased affordability. Further, the housing supply is near record-lows. 

A strong housing market has several positive, knock-on effects. It leads to increased consumer confidence. People are more likely to spend to upgrade their homes. It increases the job opportunities and wages of blue-collar workers.

Manufacturing

One of the persistent drags on the economy from 2018 has been manufacturing. In part, it was due to the trade war between the US and China. A new administration could lead to a more, non-confrontational approach and a fresh start in negotiations. 

The ISM report shows us that New Orders are leaping higher, while Inventories are low. This is consistent with the notion that a new cycle is beginning.

(ISM New Orders Index; Investing.com)

3 Stocks to Consider

Given these positive developments, investors should expect accelerating economic growth in 2021. Investment success in this environment will require a different strategy than what has worked during the last bull market.

Cyclical stocks that are connected to the real economy will see the biggest gains. Further, many of these stocks have reasonable valuations, during a time in which many companies have sky-high valuations. History shows us that these ingredients are a recipe for outperformance.

Three stocks that investors should consider buying are Caterpillar (CAT), Hess Corporation (HES), and JP Morgan (JPM). 

Caterpillar (CAT)

CAT is the world’s largest maker of construction equipment. It will certainly benefit from the strong housing market. Another boost is that fiscal stimulus is being aggressively deployed in countries all over the world. A major recipient will be infrastructure projects which will also benefit CAT. 

CAT’s fortunes are closely tied to China given the country’s size, growth, and large industrial economy. The Chinese economy has essentially moved past the coronavirus and is on the mend. This is another reason to be bullish on the stock. 

Finally, CAT has attractive financials with a forward price-to-earnings ratio of 24 which is cheaper than the S&P 500. Further, it expects average revenue growth of 12% over the next five years which is also better than the S&P 500. It also pays a 2.2% dividend which is higher than the S&P 500.

CAT is rated a Strong Buy by the POWR Ratings. It has an “A” for Trade Grade, Buy & Hold Grade, and Peer Grade with a “B” for Industry Rank. Among Industrial – Machinery stocks, it’s ranked #2 out of 62.

Hess (HES)

A strong economy also means increased demand for oil. This year, one of the most surreal moments was the front-month contract of oil going negative. In hindsight, this may have been a textbook, contrarian indication that a new bull market in oil was beginning.

Oil has been a laggard since 2014. The major factor was the increased oil supply. However, oil’s poor performance from 2014 to 2020 has resulted in diminished CAPEX, oil projects being shut-off, and investors losing interest in the sector.

Therefore, if demand comes back, supply won’t be able to immediately be ramped up to match it. We could have tightness in the oil market. So, investors should have some energy exposure.

HES is a high-quality, diversified oil and natural gas producer. Its stock is about 50% off its 2019-highs despite recent strength in energy stocks. Both commodities have similar dynamics in that a long-term, bear market has depleted rig counts and exploration budgets which make them ripe for a squeeze if economic growth surprises to the upside.

The POWR Ratings rate HESS a Buy. It has an “A” for Trade Grade and Peer Grade. Among Energy – Oil & Gas stocks, it’s ranked #4 out of 97.

JPMorgan (JPM)

Another beneficiary of accelerating economic growth will be the banks. Faster growth means that longer-term rates will tick higher. The Fed is committed to keeping the short-end at zero, so a steeper yield curve means its core business of taking deposits and lending money becomes more profitable.

A strong economy also means that there will be fewer defaults. Due to uncertainty from the coronavirus, JPMorgan has set aside $34 billion in loan-loss reserves. Another catalyst for the sector is the Fed allowing dividend hikes and share buybacks which will increase the stock’s attractiveness, especially in a zero-rate world.

Since the Great Recession, banks have underperformed. Some reasons were increased regulation, the bear market in long-term rates, and weakness in economic activity. For strong banks like JPM, it was an opportunity to gain market share and get stronger. 

From a valuation basis, the stock looks quite attractive with a forward price-to-earnings ratio of 13 and a dividend yield of 2.9%. The POWR Ratings are constructive on JPM as well as it has a Buy rating. It has an “A” for Trade Grade with a “B” for Buy & Hold Grade, Peer Grade, and Industry Rank. Among Money Center Banks, it’s ranked #3 out of 10.

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JPM shares were trading at $122.66 per share on Tuesday afternoon, down $0.89 (-0.72%). Year-to-date, JPM has declined -8.81%, versus a 15.71% rise in the benchmark S&P 500 index during the same period.

About the Author: Jaimini Desai

Jaimini Desai has been a financial writer and reporter for nearly a decade. His goal is to help readers identify risks and opportunities in the markets. He is the Chief Growth Strategist for StockNews.com and the editor of the POWR Growth and POWR Stocks Under $10 newsletters. Learn more about Jaimini’s background, along with links to his most recent articles. More...

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