Stocks Stumble as Early Gains Turn to Losses to Start 2021

The fear trade returns, while the Sell-Side Indicator speaks up

2021 started right where 2020 left off — robust stock market gains and rising commodity prices in the face of more COVID-19 cases, a new and highly contagious variant of the virus, and political uncertainty. Then things got messy. The DJIA gave up a 200-point gain and swung to a 725-point loss before bouncing off the lows in the late afternoon. The S&P 500 and the Nasdaq gave up similar gains and the , or Volatility Index, spiked 25% to ring in the new year. Gold hit its highest level in nine months as fear crept back into the market. 

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Financial media pundits postulated that the political winds in Georgia, which has an important election runoff tomorrow that could determine the balance of power in Congress, may have blown sour sentiment into the market. As the Democratic candidates improved in the polls, and the likelihood of a Democrat-controlled Senate increased, those pundits warned that the Biden administration will be able to pass a big tax increase on corporations and wealthy individuals.

Or maybe investors were scared by the new lockdown restrictions imposed by U.K. Prime Minister Boris Johnson due to the resurgence of the virus? Or maybe the slow rollout of vaccines in the U.S. wore on investors' patience? Or maybe investors finally booked some profits from 2020, preferring to lock in gains before the uncertainty of a new year takes hold? Pick your reason — there are many.

As it turns out, stocks fell pretty hard on the first trading days of 2001 and 2008. Those were ugly years for equity investors. Heavy volatility, though, is very common on the first trading day of the year.

S&P 500 median absolute percentage change by day of the year
Chart courtesy Bianco Research.

The Fear Trade Returns

Remember the most terrifying days in the stock market in the summer of 2020? Those were the days when the vaccine rollout seemed years away and we thought we'd be working from home until 2024. 

We caught a little taste of that fear today as the stay-at-home stocks, vaccine makers, and Tesla all rallied, while the recovery-related sectors all faded. Cruise lines, airlines, and hotel stocks all retreated as investors went back to their 2020 battle plans of playing offense and defense at the same time.

Share price chart

Sell-Side Indicator Speaks Up

Wall Street strategists were fairly bullish coming into the end of 2020, but not overly exuberant. The Bank of America Research Sell-Side Indicator, which is based on the average recommended equity allocation of Wall Street strategists as of the last business day of each month, was tilting toward extreme bullishness as the year wound down, which has been a reliable contrarian indicator. The more optimistic these strategists get, the weaker the returns over a 12-month basis. 

Their optimism rested in the rollout of vaccines, the reopening trade as consumers rushed to spend money on the things they haven't been spending on, and the expectation for higher corporate profits ahead.

The realities of the vaccine rollout and consumer demand, however, may have creeped into investors' psyches today, given the steep and sudden reversal inside the major equity markets. Still, strategists are pretty neutral right now, which means markets may stay that way for awhile too.

Sell Side Consensus Indicator as of Dec. 31
Chart courtesy BofA Research.
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