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Scott Wren is Senior Equity Strategist for Wells Fargo Advisors in St. Louis. He appears regularly on CNBC, Bloomberg TV, The Nightly Business Report and in articles in the Wall Street Journal and the Financial Times.

Harlan Levy is a business reporter and columnist at the Connecticut daily newspaper the Journal Inquirer.

H.L.: Are investors losing confidence in the stock market’s upward trend, expecting a pullback?

S.W.: I think a lot of investors have been expecting a pullback since June or July, and that’s one of the reasons why we’ve been able to push higher.

A lot of people, both professional and retail investors, have missed a lot of this move that we’ve seen off the March lows and have been waiting and hoping for a pullback. We have not had a lot of people chasing the market, and that typically allows the market to run a little higher, especially in the face of better economic news and much better than expected earnings two quarters in a row.

Investors have coming to the realization that earnings estimates for this year, 2010, and 2011 are probably too low. We’ve been telling our clients that our estimates for the last month or so are starting to look too low for all of those years, and our estimates are higher than consensus estimates. Now we’re telling our clients that we’re likely to raise our earnings estimates, and we’re likely to raise our targets as a result of that.

H.L.:
We’re at the start of the seasonal low in stock trading volume. So, should investors focus more on price action than the declining volume as an indicator of the market’s direction?

S.W.:
Volume has been declining, and volume has not been a good indicator for a while, particularly for most of this rally. So in the near term we are likely to get some pullback and consolidation.

If we have a couple of months of that, that would make some sense. It would create some opportunities for those who missed this run-up, because what clients need to be doing is looking out a couple of years and making sure of their positions for that time frame. They should not be concerned about what’s happening over the next couple of months. Investors need to make sure that they have overweight exposures to those sectors that are most sensitive to an economic recovery both here in the United States and globally.

H.L.:
What are those sectors?

S.W.:
Sectors that we like are industrials and the materials sector. We also think clients should have an even-weight exposure in the consumer discretionary sector.

They need to be underweight in the more defensive sectors that are less sensitive to the economic cycle, like health care, utilities, and consumer staples.

H.L.:
Is the credit crunch getting worse?

S.W.:
I think that the demand for credit is very low. We all know that it’s tougher to get credit, but what a lot of people don’t realize is the demand for credit is unusually low for this point in the cycle.

I don’t know if it’s necessarily a credit crunch, but companies and individuals are hesitant to borrow. Smaller companies are particularly hesitant to borrow, because they’re very uncertain what is coming as far as the tax structure and any other governmental regulation that they’ll have to deal with.

H.L.:
But a lot of people think that the banks are really holding back on loans and investing in securities instead to make a pile of cash. Is that wrong?

S.W.:
Credit standards were way too loose and needed to be tightened up, and banks and other financial institutions are just trying to improve their balance sheets and prepare for a better economy ahead.

H.L.:
The jobless numbers don’t seem to be getting better fast enough for investors. What’s your take?

S.W.:
At some point that’s going to come into play, but right now companies’ margins are expanding , and company productivity is high, so you’re going to see companies recover a lot faster than employment.
Companies are trying to squeeze as much out of every employee that they have. They’re very hesitant to add new employees.

H.L.:
What do you see ahead next year?

S.W.:
Next year you’re going to see more cyclical recovery and a higher stock market. A year from now, the stock market could be as much as 12 to 15 percent higher than where it is now.

H.L.:
What about the dollar? It seems to be dominating the market so that when it weakens stocks surge, and when it strengthen, stocks go down.

S.W.:
It wouldn’t surprise me to see the dollar rally a little bit. Everybody’s playing it for a lower dollar, and when that happens it usually doesn’t pan out that way.

H.L.:
Is the housing market about to recover?

S.W.:
There are a lot of people out there wanting to sell their houses who are waiting for better prices and some stability. So I think it’s going to be hard for housing prices to recover a lot over the next few years. Also, there are a lot of houses that banks own that they want to sell, so there’s a lot of supply out there. That should keep a lid on prices.

If people perceive that the housing market is stable and the prices of their homes are not going to go down a lot from here, that builds confidence and helps consumers feel a little bit better about discretionary spending. If consumers are more willing to spend money that will help the economy. We expect modest economic growth next year.

Source: Interview with Scott Wren: Forward Earnings Estimates Are Too Low