2021 stock market outlook: Why investors aren't abandoning tech stocks yet

This article is part of Fortune‘s quarterly investment guide for Q1 2021.

If there’s one valuable takeaway from 2020, it’s this: Even amateur investors learned how to make a buck in a pandemic.

The break-the-glass instructions, it turns out, were pretty straightforward. They read…

1) Keep calm. 2) Wait for the Federal Reserve to slash rates to near zero. 3) Go overweight on the “anything and everything tech” trade. 4) Don’t gloat about your returns on Twitter; there are others who aren’t doing so well.

Okay, it’s perfectly fine to ignore No. 4.

To recap, tech stocks had their best year since 2009. The Nasdaq finished 2020 up 43.6% as investors quickly realized how to play the lockdown trade: You pile into work-from-home stocks, anything from cloud providers (think SNOW and its 112% pop upon going public) to streaming platforms (NFLX, up 64.3% in 2020) to meal-delivery services (UBER, up 69% in 2020).

It was a perfectly sensible move. The balance sheets of growth stocks, it was rightly assumed, would be best positioned to withstand the worst of the pandemic. That conviction became gospel as the long-tech trade in 2020 became the most overcrowded trade Bank of America equities analysts had ever seen.

Tech was so dominant it lifted indexes from Tokyo to Seoul to Frankfurt. Many of the worst global performers (we’re looking at you, FTSE) had one big thing in common: They were underweight tech stocks.

A wise investor would look at that winning hand and say, I’m not changing a thing. But there are plenty of signs that Big Tech faces big challenges if it’s to retain the crown in 2021.

“Last year,” says Mike Stritch, chief investment officer and national head of investments for BMO Wealth Management, “we were very bullish on the tech story, starting back in the midst of the COVID market selloff in March.

“And that worked out well,” he continues. By mid-autumn, however, “we’ve taken some chips off the table in favor of more cyclical areas.”

BMO followed a path many on Wall Street have taken over the past three months. After its 2020 bull run, tech is viewed as too pricey. The better returns for 2021 are seen in value stocks (think finance and energy), small caps (cast your eye on the Russell 2000), and emerging markets.

By the numbers

Fortune analyzed the returns on S&P 500 sectors, looking back one month, three months, and 12 months. The numbers bear out that we are in the midst of a great rotational trade out of growth stocks and into value stocks.

As the chart above shows, the information technology component of the S&P 500 (+34.3%) far outperformed all sectors over the past 12 months. (The numbers run through the close of markets on Jan. 15, 2021.) The worst performer was energy, off 29% over that period.

But the one-month and three-month charts tell a very different story. Tech lags the likes of health care, financials, and energy by a long way.

That bears out what Wall Street has been noticing for months: There are a few headwinds facing the tech trade that go beyond inflated valuations.

First, Big Tech faces growing antitrust risks on both sides of the Atlantic. That specter of increased regulatory oversight has sunk shares, particularly, of the social media giants in recent weeks. As of the Jan. 15 close, Twitter was down 12.2% since it had booted Donald Trump off its platform, and Facebook was off 6.1% over the same period.

That dark cloud won’t blow out of town anytime soon.

The second factor to watch is the reflation trade. If the COVID vaccine rollout goes as planned (that’s hardly a given), the locked-down parts of the economy will begin to reopen, meaning there’s renewed upside for beaten-down industries like airlines and travel, leisure and energy. It’s those kind of assets that could draw investors’ money away from pricey tech stocks. As our chart shows, investors are increasingly risk-on the reflation trade.

The recovery trade is a bet on broader growth. That, and a vow by the Biden administration to deliver further rounds of stimulus spending, is expected to nudge price pressures higher along with the nominal yield on bonds. (This is anything but certain, mind you, but more and more investors are betting on such a scenario.) Rising prices and the expectation for higher interest rates is usually bad news for risky assets. And that’s what’s dragging on growth stocks. That would be a third big headwind for tech stocks.

Where to look

It’s important to note that nobody thinks a portfolio rich in tech stocks is doomed to fail in 2021. As BofA Securities notes, being long-tech is still the most popular trade out there, even after investors pulled billions out of the trade in the last quarter of 2020. (Long-tech is merely crowded today; not historically overcrowded.)

So what about tech still catches investors’ eye?

BMO’s Stritch sees plenty of organic growth in enterprise software and hardware. “If I think about capex and where that money is going these days, it’s going more towards that software and tech equipment side,” he says. “And that will continue going forward.”

What could lag are those parts of the tech sector that are most vulnerable to a reopening economy. Once movie theaters fully reopen, do we really need a subscription to three different online streaming services? Similarly, if it’s safe to go back to the office, or even attend business conferences, organizations will have to decide—is it time to ditch one of the following: Zoom, Teams, or RingCentral?

As the global economy comes back, companies and consumers will be making big decisions about the future—and a number of little ones that, added up, will be significant for Big Tech and Little Tech alike.

In this way, the recovery trade of 2021 won’t be nearly as straightforward as the pandemic trade of 2020.