A Wall Street chief strategist explains how the shockingly quick onset of pandemic fear may have set up both the economy and stock market for a surprisingly strong 2021

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• The sharp reaction to the coronavirus pandemic through widespread saving and economic policy could boost the US recovery in 2021, James Paulsen, chief investment strategist at The Leuthold Group, said in a Friday note.
• The government's degree of policy support dwarfs that seen during recessions in the 1980s and 2008. 
• Companies took similarly drastic precautions by slashing extraneous costs to lower breakeven points, Paulsen noted.
• Americans reacted by saving more and taking defensive positions with their investments.
• These trends "could combine to produce an unexpectedly strong economy in 2021 and, perhaps, a surprising further rise in the stock market," the strategist said.
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Leaders in government, business, and finance might all be overreacting to the coronavirus pandemic, James Paulsen, chief investment strategist at The Leuthold Group, said in a Friday note.

That overreaction could be exactly what the economy needs to thrive through 2021, he added.

By some gauges, the V-shaped rebound hoped for by most economists has played out. The stock market retook its pre-pandemic highs and touched record highs just weeks ago. Purchasing managers' indexes show the US manufacturing industry roaring back to life. Retail sales quickly bounced back in May and continue to trend higher.

To be sure, other gauges signal there's plenty of room for recovery before the economy is back on track. Lasting pain in the labor market has led the government officials to leave much of their policy support in place. But the unprecedented level of aid, as well as the potential for a second stimulus bill, stands to boost the economy well after it fully recovers, Paulsen said.

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For one, annual M2 money-supply growth sits at nearly 25%. The same metric reached just 11% the first time the unemployment rate was at 8.4% in 1983. After the financial crisis, money-supply growth was 10% when the unemployment rate slid below today's level.

"What does their outsized, over-reactionary 2020 economic policy suggest about economic and earnings growth in 2021?" the strategist said.

In the private sector, companies have made their own precautionary moves. Firms "moved quickly and decisively to scale back operations and lower breakeven points" as the virus roiled economic activity, Paulsen said. The moves set up companies to record strong profits and enjoy new efficiencies once the US fully reopens and the virus threat subsides.

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Finally, Americans are largely waiting on the sidelines even as several metrics suggest the opposite. The household savings rate sits at 18%, a historically high level, even after surging to 33.7% earlier in the pandemic. That reading "implies that stimulus checks are so far not being spent," Paulsen said, leaving swaths of cash ready to boost the economy.

The Leuthold Group

Separately, credit card debt has steadily declined through the downturn. In previous recessions, balances generally didn't drop until well after the slump.

Invested Americans exhibited similar behavior. Despite major indexes sitting just below record highs, hundreds of billions of dollars in investor capital moved from stocks to safe havens and remain there. The American Association of Individual Investors' survey backs up the trend, as the share of bears versus bulls has trended higher by 10% to 30% since March, Paulsen noted.

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"The COVID collapse has left investors sitting on a considerable amount of dry powder, over-weighted with defensive assets, and pessimistic about future financial-market scenarios," he added.

The coronavirus crisis and subsequent recession is likely the most emotional recession faced by Americans, Paulsen said. While an overreaction is "understandable," it also drives behavior that will shape the nation's recovery into 2021 and beyond.

Once the coronavirus is handled, the cocktail of accommodative economic policy, healthy household saving, defensive investing, and corporate efficiencies will likely drive an "unexpectedly strong economy in 2021 and, perhaps, a surprising further rise in the stock market," the strategist added.

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