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3 things stock experts' top picks suggest about the stock market and economy in 2021

Investment analysts' favorite stocks reveal what they're thinking about the market and the economy.

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If 2020 taught investors anything, it was that markets and the events that shape them are impossible to accurately predict. But that hasn't stopped market prognosticators from trying.

After all, a new year represents a fresh start — another chance for Wall Street firms to show that the research and expertise that they provide can make their clients money. In that vein, over the past month or so, analysts at investment banks' research arms have released their top stock picks for the 2021.

And the stocks that analysts are eyeing can give investors clues about what to expect from the market and the economy this year.

Who makes the stock picks

If you see financial headlines indicating that someone has assigned a "buy," "sell," or "hold" rating on a stock, that guidance is typically coming from a so-called "sell-side" analyst at a major investment bank. It's these analysts' job to make investment recommendations based on projections for publicly traded companies' financial performance. These folks regularly issue research reports on segments of the stock market and on individual companies. These reports often include year-ahead projections for a firm's financial fundamentals, such as earnings, as well as a price target — the price analysts expect a stock to trade for after a particular amount of time, often 12 months.

Sell-side analysts make money for their employers by convincing institutional investors to buy and sell stocks through the investment bank's trading desk. Analysts want to be seen as providing valuable new information and insights about the stocks they cover. But it also means that such analysts can be prone to excessive bullishness in the interest of drumming up interest in the stocks they cover.

Thinking of buying shares of 'top picks'? Be careful

If an analyst issues a "buy" rating for a stock (or an equivalent designation, such as "outperform" or "overweight"), it typically means that they expect the stock to outperform the broad stock market over the next 12 months. Analysts' "top picks" aren't necessarily the stocks analysts expect to generate the largest return. Rather, among a certain subset of firms (say, companies in a particular sector or industry), these are the ones the analyst is most confident can deliver market-beating results in 2021.

But a recommendation from an analyst alone isn't reason enough to buy a hot name. For one thing, you shouldn't branch into buying individual stocks until you have a broadly diversified portfolio, preferably one built with low-cost mutual funds and exchange-traded funds. By not keeping all your eggs in one basket, you protect your portfolio from ruin should one of your investments plummet.

And even if the analyst is right, you're not investing for a single year of returns. You should buy only if you think you're investing in a quality firm that can deliver strong returns for years to come. Take it from Warren Buffett: "Nobody buys a farm based on whether they think it's going to rain next year," he said on CNBC's "Squawk Box" in 2018. "They buy it because they think it's a good investment over 10 or 20 years."

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What 2021 'top' stock picks reveal

An analyst's projection for an individual stock is ultimately, well, individual. Investment recommendations and target prices are calculated from analysts' projections for a company's business fundamentals. But if you view these individualized picks as a part of the larger picture, you can get some ideas as to how the pros feel about the future of the stock market and the economy this year.

Pharmaceuticals and cloud computing remain exciting plays, but analysts are being selective

If you're bullish on a particular sector or industry, analysts would tell you to home in on financially strong firms that are trading at a discount to peer firms. Does that sound familiar? It should — that tactic is known as value investing, and it's the favored strategy of none other than Warren Buffett himself.

Analysts at RBC Capital Markets, for instance, highlight immunology and oncology firm AbbVie as a top pick among pharmaceutical companies in 2021. The market undervalues the firm's shares, the analysts say, due to a projected revenue decline in 2023, when peers will be allowed to sell biosimilars to compete with AbbVie's flagship drug, Humira.

And while Piper Sandler analysts are enthusiastic about microchip companies, which stand to benefit from businesses' continued shift toward cloud computing, their top pick, Broadcom, "remains cheaper relative to other players in the space, while offering much better financial metrics."

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They expect things to return to normal ... eventually

Most professional market watchers are expecting the economy to open back up significantly in the second half of the year, given the timing for vaccine distribution. But market watchers are hedging their bets. Many of analysts' favorite stocks for 2021 have one business line that can continue to succeed should quarantine conditions last longer than expected, and another that stands to benefit as things get back to normal.

Take Uber, a favorite of Deutsche Bank and Morgan Stanley. Analysts expect a sharp recovery in Uber's ride-sharing business in the second half of the year as the vaccine rolls out to the general population. In the meantime, they expect Uber to continue to improve profitability in its Uber Eats food delivery businesses.

The same rationale applies to Dell, a top pick of Citi Research. They see the computing firm benefiting from continued strong consumer demand for PCs, tablets, monitors, and webcams through the first half of the year as consumers continue to work remotely and school their kids virtually. The second half of the year should bring a wave of spending on corporate infrastructure (a major business line of Dell's) as normal business operations begin to resume, the analysts say.

They think some pandemic shifts are here to stay

The Covid-19 pandemic changed the way that businesses and consumers operate in 2020. And while some behavioral shifts are likely to fall by the wayside when the world reopens, stock experts think that others are likely permanent.

For example, the pandemic merely accelerated a long-term shift to streaming and cord-cutting, say analysts at Goldman Sachs. They expect top pick Disney to "expand its lead" in providing direct-to-consumer content through its Disney+ and Star streaming platforms.

Analysts at Needham note that lockdown measures boosted the trend of folks doing more of their shopping online. They're counting on top pick Chewy, an online retailer of food and other products for pets, to keep growing its customer base of online pet shoppers as folks continue to choose e-commerce over doing their shopping in person.

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