Interview With Scott Wren: Stocks May Drop 5 Or 6%, But S&P 500 Will End Year Higher

 |  Includes: DIA, QQQ, SPY
by: Harlan Levy

Scott L. Wren is a senior equity strategist with Wells Fargo Advisors. Previously, he was a senior equity strategist with A.G Edwards.

Harlan Levy: What does the better than expected June jobs report - 195,000 new jobs - tell you about the U.S. economy?

Scott Wren: I think the jobs report and the revisions were good. There's no doubt about that. But it doesn't change my mind that we're in a modest growth, modest inflation economy, and that's not going to change any time soon. If you consider that the U.S. needs to add about 125,000 jobs a month just to keep up with new entrants into the labor market, when you have a rate like 195,000, even though it's better than expected, you only reduce the unemployment rate slowly, all things being equal.

Those numbers were good. They weren't great. When I look over the 30 years I've been doing this, a good labor market is when you're taking on 250,000, or 300,000 a month. Those are the numbers that push the unemployment rate down quickly. Those are numbers you would see in a good economy, not a slow-growth economy.

H.L.: So what's your prediction for the U.S. economy for the rest of 2013 and 2014?

S.W.: First-Quarter Gross Domestic Product was not great, and second-quarter GDP is probably not going to be good. We thought we'd see GDP growth for the full year at around 2.5 percent, but that may be a little optimistic.

I think next year will also be a modest-growth year as well, maybe with 2.5 percent growth. You'll see a slight improvement in the unemployment rate, and you'll see economic growth a little better in the second half of next year. You'll continue to see consumer and business confidence slowly improve.

H.L.: What's your take on other factors that affect the U.S. economy, like housing?

S.W.: The jump in interest rates will create a headwind for the housing recovery. I don't think it's going to ruin it, since rates are so low. But it's going to create a headwind, and I would guess that some of the home sales we've seen in the data on may not go through, because home buyers may have a tougher time getting the credit they need in a higher mortgage-rate environment.

Employment, housing, and confidence are three very important things, and I think they will continue to slowly improve as we move through the rest of this year as well as next year.

H.L.: Do you think the sequester -- the $1.2 trillion spending cut over 10 years -- is having or will have a seriously bad effect?

S.W.: The sequester cuts are very minimal. I see them as very small and insignificant. If you really want to address our long-term fiscal issues, which we will have to, I'd rather not do it in a crisis but over 10 years, but the sequester over a 10-year period is as close to meaningless as you can get. It doesn't even move the needle. If you look at the formula for economic growth, out of GDP, you can say "G" for government spending. When you back away from government spending you're taking away from the calculation for economic growth.

The sequester does create a headwind, but you have to make much more of an adjustment at some point. But I seriously doubt that politicians would even cut spending if the economy was growing at, say, 4 percent. Any time you cut government spending it's going to create a headwind for economic growth. Plus, the payroll taxes are higher. You have other higher taxes, because the economy is generating more taxes. The annual deficit is coming down some, and we don't have a crisis, so I seriously doubt we're going to see any serious spending cuts coming out of Washington, no grand bargain. Politicians may come up with something they'll say is a grand bargain, but it won't be. It will be minimal.

In the end, our kids and grandkids will be paying higher taxes and receiving entitlement cuts, It will happen. The only question is when. Do you wait until the crisis, like Europe? Or do you do it slowly over time when there is no crisis? That's the best way to do it, but politicians won't do it over time, because they won't get elected, so they won't do it.

H.L.: Stocks have been reacting negatively to good economic news because Wall Street sees it as an indication that the Federal Reserve will soon begin reducing its monthly bond purchases, which have been propping up stocks. Is this foolish, impulsive, and just a short-term knee-jerk reaction?

S.W.: We're not in a full-blown "what's bad is good" mode right now. We don't think we're there yet. People are happy with the employment number, but stocks dropped off the highs after that news came out. The market is still trying to adjust for data that increases the likelihood that the Fed is going to taper. The market is worried about when and how much they will do. They don't want the Fed to cut back too much too soon, and that's what investors are worried about.

I think the monthly reduction will start in 2014. I haven't changed my mind because of the jobs data. Inflation is falling, and the Fed is worried about it being too low. We had 1.8 percent growth in the first quarter, and we're probably going to see 1.5 percent or 1.7 percent in the second quarter. So why would the Fed start tapering off the bond purchases in those types of conditions: slow economic growth and falling inflation. The bottom line is that the Fed is going to remain very, very easy for a long, long time. The market is reading too much into every nuance from what it says. Whatever happens with this tapering, it's not like the Fed is going to tap the brakes. That won't happen for years.

When the Fed said it could begin tapering sooner than later it really could have been worried about stock bubbles bursting. We basically went up 23 percent straight since the November lows. Housing prices are up 12 percent year-over-year. The Fed doesn't want stocks going up 23 percent every year, and they don't want housing prices to go up 12 percent. The Fed could have taken the wind out of both markets intentionally by talking about tapering sooner than later. The last thing it wants is to have another stock or housing bubble. If that's what the Fed wanted to do, it worked. That could be part of the plan, if you're a conspiracy theorist kind of guy, which I'm generally not, but what the Fed does is usually very planned out and orchestrated.

H.L.: Is the stock market headed for a pullback, and if so how much of one?

S.W.: I would like to see more pullback. Pullbacks are opportunities. I think volatility will remain high, and we'll see more back and forth. We could certainly trade down 5 or 6 percent from here. But we'll end the year higher than where we are now, going to 1,650 or 1,700 for the S&P 500, a target we bumped up three weeks ago. If we're right, and the market ends up higher, we certainly want to be buying in pullbacks.

H.L.: What sectors of the market do you like and dislike?

S.W.: We still like economically sensitive sectors. The sectors we want to focus on will benefit from the continuation of the recovery. When you look at things like materials, technology, the industrials, those should benefit in the course of the next 12 months.

The things you want to be underweight are utilities, consumer staples, healthcare, the more defensive sectors.

H.L.: Is the assault on bank reform a bad idea?

S.W.: It's the guys in the industry who are attacking bank reform. But any bank reform that doesn't require the appropriate amount of capital is missing the mark. That's the most important part of any bank reform. I still have concerns about "too big to fail." I want to be sure banks have enough capital to withstand some market disruption. But generally, government regulation in the wake of crisis situations tends to be too much, and you'll see continuing arguments about how much capital they need and what constitutes capital.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.