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2021 stock market outlook: 3 expert predictions on what could affect your portfolio

Wells Fargo analysts expect small firms to lead the way and large companies to underperform.

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In financial markets, as with everything else, no one can predict the future. Nevertheless, the beginning of the year marks the time when investing analysts and researchers make their predictions for the year ahead in the stock market.

What does the future hold for investors? Lately, market-seers' crystal balls have revealed a mostly placid, positive picture for the U.S. stock market and economy. That doesn't mean you're free to ignore your portfolio for the rest of the year, however.

Read on for three financial predictions that market experts are making and how to adjust your portfolio to take advantage.

As the economy recovers, stocks will continue to rise

As vaccine distribution picks up throughout the year, analysts expect the global economy to grow in 2021. Sam Stovall, chief investment strategist at investment research firm CFRA, expects a 5.5% bump in U.S. economic output in 2021, continuing an economic recovery that began in the third quarter of 2020. Economies in every region of the world are expected to bounce back, Stovall says, with growth ranging from about 3% to 8%.

A growing economy bodes well for corporate earnings, which analysts, on average, expect to grow by 21% in 2021, according to data from S&P Capital IQ. Some analysts are more bullish than that. "We potentially could see S&P 500 earnings growth of 25% in 2021, boosted by cost-efficiencies achieved during the pandemic," say analysts at LPL Financial. That compares with a 10% average earnings growth rate for companies in the index over the past 10 years, according to FactSet.

That should lead to a good year for stocks, analysts say. Researchers at J.P. Morgan, for instance, expect investors to pile into the market in the first half of the year, given what they call a "market nirvana" scenario for equities as the economy continues to recover. Investor exuberance should wear off a bit in the second half, they say, and they expect the S&P 500 to end the year at 4,400 (though potentially between 4,200 and 4,600). That's a near 16% increase from current levels.

That doesn't mean that you should shove every nickel you have into the stock market based on these analysts' expectations. But if you're keeping your money on the sidelines until a marked pullback in stocks presents a buying opportunity, the current wisdom suggests you may be waiting for a while. And the longer you wait to get into the market, the more you give up your greatest asset as a long-term investor: time.

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New leaders are expected to emerge

For all of the turmoil along the way, last year ended up being a good one for stocks: The S&P 500 returned an impressive 18%. But it wasn't a scenario in which a rising tide lifted all boats. While technology names, especially those that stood to benefit from Americans' shift to doing more work from home, posted huge returns, companies whose bottom lines suffered as a result of Covid-related shutdowns saw their stocks plummet.

While analysts on aggregate expect stocks to enjoy a good year in 2021, they also expect many of the trends that emerged in 2020 to reverse course. Analysts at Wells Fargo are calling 2021 "The Year of Regime Change."

One shift they expect: leadership among small-company stocks. Although megasize firms contributed to much of the gains coming out of the depths of the pandemic, Wells Fargo's analysts expect small firms to lead the way in 2021, with large companies slated to underperform the average stock.

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Analysts at BCA Research are among many who expect foreign stocks to outperform U.S. stocks this year after lagging badly in 2020. A slower recovery for overseas stocks in developed and emerging markets have them looking cheap compared to U.S. names, the analysts say, and they should benefit from a U.S. dollar that analysts expect to continue to grow weaker against foreign currencies. (A weakening dollar helps U.S. investors in foreign firms because their foreign-currency profits get converted into more greenbacks.)

Technology stocks' run at the top may be coming to an end, too. "It makes sense to favor stocks that were crushed by lockdown measures but could thrive once restrictions are lifted," BCA analysts say. Most analysts agree. Analysts at J.P. Morgan highlight consumer firms, such as those in the leisure, hotel, and restaurant industries, as those most poised for a comeback.

The best way to play a year of new leadership in the stock market: Make sure you're adequately diversified. Spreading your bets among different types of investments — such as firms of different sizes, stocks with growth vs. value characteristics, and companies domiciled in different countries — ensures that part of your portfolio is always working, and that your overall investment picture won't be dragged down by one poor-performing asset class.

Even if you already had a diversified mix heading into 2020, your portfolio likely doesn't look the way you left it. "After a record-breaking market sell-off and recovery, it's likely that your asset allocation is no longer where it started," say analysts at investment bank UBS.

As a result of last year's runup, you may find yourself with a larger proportion of stocks to bonds than you had previously planned for, or with a larger portion of your stock holdings invested in high-flying tech names than you're comfortable with. If that's the case, it may be worth selling some of your winners to get back to your target allocation.

Low risk doesn't mean no risk

Even while giving rosy predictions for stocks and the economy, market prognosticators had to acknowledge potential risks to their predictions. J.P. Morgan analysts don't think investors should be concerned about sky-high price tags for stocks, given the high sales growth projections and the relatively paltry returns investors could find in the bond market.

Analysts nevertheless acknowledge that the forward price-to-earnings ratio of more than 22 for the S&P 500 means that stocks have only been more richly priced 4% of the time since 1985, which should raise investor eyebrows.

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Analysts nearly across the board expect market forces stock investors hate, such as inflation and rising interest rates, to stay at bay in 2021, and most think that a relatively centrist government will fail to pass legislation that could meaningfully ding U.S. companies, such as a sweeping tax hike or strict corporate regulations.

But risks remain, and if 2020 taught investors anything, it was that even the sharpest investing minds can't always predict the events that can have an outside impact on peoples' finances. Among New Year's resolutions issued by UBS, building an emergency fund tops the list. Every investor, UBS analysts say, should build a fund that's "separate from the longer-term invested capital and the volatility that comes with investing in stocks."

They recommend building an emergency fund to accommodate 6 to 12 months of expenses. If that sounds daunting, start small. To get to $1,000 in 2021 (a sum that would put you ahead of 41% of Americans) you'd have to contribute $36 per biweekly paycheck. 

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