This is my 9th annual forecast of the S&P 500 Index return for the year. This forecast tends to predict a general pattern, direction, of the stock market in the future. When the forecast calls for a negative return, it is a warning sign. It means that the market is ahead of itself and may see a poor performance and volatility in the next 12 months. My forecast does not predict an absolute number rather it gives an overall feeling for the general direction of the stock market in the future.
The year 2021 maybe a bad year for the S&P 500 Index. My model predicts a negative return for the year 2021. This means that the stock market is ahead of itself and may experience a correction and volatility in the next 12 months.
My model is based on the simple linear regression model. The model uses Gross Domestic Product (GDP) as explanatory variable to the performance of the S&P 500 Index. The model predicts the S&P 500 Index to close between 3,390 and 3,480 at the end of the year 2021. This represents a negative return between -7.3% and -9.7% for the year. If my forecast is correct, the year 2021 will provide a negative return to equity investors. Investors may not be fully compensated for taking the market risk. It is time to be cautious about taking on equity risk.
During the last eight years, the model had proven to predict the general direction of the stock market performance. Projections by the model and actual stock market performance track each other (see Chart 1). Even for the year 2020, the model predicted a decline in returns which was a correct trend from the prior year. For the year 2021 the model predicts a significant negative return between -7.3% and -9.7%. This should make investors more cautious during the next 12 months.
When I compare historical predictions for the S&P500 Index performance with actual returns of the S&P500 Index, I can see a positive correlation (see Chart 1). The model may provide a general understanding of whether the stock market is overprices or inexpensive. The model does not guarantee or precisely predicts the outcome. It has correctly projected up and down markets six out of eight years (see Table 1). Despite a significant margin of error, the model does give a general feel for the value of the stock market. It does track the performance of the stock market.
The forecast model may provide the basis to evaluate the stock market and to determine if it is oversold or underbought. There is also a wide margin of error. The expected performance for the S&P 500 Index may have a wide deviation from the actual index each year.
Now, let’s review the forecast for the year 2021. Where will the S&P 500 Index close one year from now, on December 31, 2021?
Based on the statistical analysis and the process described further in this article, I expect the S&P 500 Index to close between 3,390 and 3,480 at the end of 2021. Based on this range, the midpoint for the S&P 500 Index is predicted to be at 3,435 on December 31, 2021 (see Table 1). This translates into a potential annual decline of -8.5% for the S&P 500 Index.
This prognosis is based on expected Gross Domestic Product (GDP) of the United States in nominal terms, current USD terms. First, I take the most recent GDP number. It will be the base from which I calculate the expected nominal GDP. According to the Bureau of Economic Analysis, the current dollar GDP was $21,170.3 billion for the third quarter of 2020 year (December 22, 2020).
According to the economic projections of the Federal Reserve Bank Board Members and Federal Reserve Bank Presidents made on December 16, 2020, the real GDP is expected to increase between 3.7% and 5.0%, and Personal Consumption Expenditure is expected to increase between 1.7% and 1.9% for the year 2021. As a result, the nominal GDP estimated to rise between 5.4% and 6.9% in 2021.
By multiplying the current dollar GDP for 2020 by expected nominal change for the year, I calculate the GDP for the year 2021 to be between $22,313.50 and $22,631.05 billion. Now I can forecast where the S&P 500 Index will close at the end of 2021. I am using the Excel spreadsheet to run a linear regression model where the S&P 500 is a dependent variable, and GDP is the independent variable. Based on the last 15 years of annual data, I forecast the S&P 500 Index to close between 3,390 and 3,480 at the end of 2021 (see Table 2).
The model predicts a significant decline in the S&P 500 Index for the year 2021. It should be a sign of caution for investors. The actual return may be significantly different from the prediction. However, the model indicates that we may experience volatility and the stock market correction in the next 12 months.
Limitations to the forecast:
Based on my prior research, the GDP alone can only explain between 67%-89% of the performance in the S&P 500 Index (see my prior articles on http://www.ecnfin.com). The remaining 11%-33% is not influenced by the GDP growth. There might be other factors that are difficult to predict; such as, geopolitical risk, rise in inflation, and black swan events that nobody expects.
By using a smaller sample of data, I am able to focus on the current economic environment. The model does not incorporate information from historical economic cycles. That was done on purpose to focus more on the current economic environment. Because of this, the sample data is limited to more recent years.
The forecast of the future S&P 500 Index is based on historical data and future expectations that may not be correct. This paper was written as an opinion only. The data is not guaranteed to be accurate or complete. Please consult with your financial advisor before making an investment decision. Neither ECNFIN.COM nor its author are responsible for any damages or losses arising from any use of this information.
ECNFIN.com and its podcast are not associated with nor do they necessarily represent the opinion or advice of Epiqwest Culver Wealth Advisors LLC. Past performance doesn’t guarantee future results.
The Federal Reserve Bank, December 16, 2020 https://www.federalreserve.gov/monetarypolicy/fomcprojtabl20201216.htm
U.S. Department of Commerce. Bureau of Economic Analysis. Gross Domestic Product data was retrieved on January 3, 2021 https://www.bea.gov/news/2020/gross-domestic-product-third-estimate-corporate-profits-revised-and-gdp-industry-third
Yahoo! Finance. S&P 500 Price Data was retrieved from http://finance.yahoo.com
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