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: Are stocks getting ahead of where they should be?
Scott Wren: I think stocks are a little bit ahead of where we thought they'd be at the end of the year. They're 6% ahead of where we thought they'd be. Our year-end target for the S&P 500 was 1,650 to 1,700, and we're ahead of that. But valuations are not stretched if you look at a price-to-earnings P/E ratio, for instance. The market is still a little bit below where we think it will end in 2014, but it's still below our 2014 year-end target level, which is 1,850 to 1,900.
I would argue that the last 100 to 120 points up in the S&P 500 have eaten at the 2014 returns. The 2014 returns will be positive, and I think we'll still end this year a little bit lower than where we are now but not a whole lot. If we close anywhere near where we are now the 2014 returns will be pretty modest, and there's some upside from here next year, but not a lot.
H.L.: What stocks do you like, and which sectors would you avoid?
S.W.: As far as sectors go, we like technology, We like the industrials, and we like the consumer discretionary sector. As for industry groups, we like things like communications equipment, which is in technology, and things like home furnishings, which is in consumer discretionaries, along with home improvement retail and household appliances.
As far as industrials, some of the groups we like are things like construction and farm machinery. We also like trucking, and we like airfreight and logistics. Another technology group we like is IT consulting and services.
Basically we want to be in those sectors and industry groups and ultimately those stocks that are sensitive to the ebb and flow of the economy.
H.L.: So what do you think the economy will do next year?
S.W.: I think the economy will be a little bit better next year compared to this year. Our economic growth estimate for this year is 2 percent. For next year 2.4 percent is our official number. We'll see a little bit better of an economy in Europe, not a lot. In the emerging market world as a whole you'll likely see a bit better performance - not a lot, but a little bit better.
That's going to help our companies here, because 50 percent of the revenues in the S&P 500 come from overseas. So part of the modest earnings growth that we're looking for, which is 5 or 6 percent next year, is fueled by better economic performance here and internationally. So we want to be in the sectors that benefit from continuing global expansion.
H.L.: What sectors will you shun?
S.W.: As for the types of sectors we want to avoid, we're underweight healthcare. We're also underweight utilities. We don't want to be defensive. We don't want to be focused on these defensive sectors. We don't want to hide, because we think things will continue to slowly improve.
H.L.: What do you think of consumer confidence?
S.W.: I think that consumer confidence will slowly improve. The partial government shutdown negatively affected consumer and business confidence, but only temporarily. And as the labor market continues to slowly improve, which we certainly expect to be the case, I think you'll see consumer sentiment and consumer confidence rise slowly and in the right direction.
H.L.: Initial claims dropped by 10,000 in the week before last. Is that part of a real trend or just an anomaly?
S.W.: Initial jobless claims are a good leading indicator. We watch it very closely. It's helpful to look at the four-week moving average because there's a lot of noise in the weekly number, so we like to look at it on a four-week moving average. And I think over the next six to eight months you're going to see it down at 300,000 or a touch below. The four-week moving average has been coming down for quite a while. But once you get down a little below 300,000, that would be a positive improvement. Our projection for the four-week moving average when we look out to next August shows it continuing to fall and getting down to 300,000 or a little below.
H.L.: What do you predict for jobs?
S.W.: I think over the next year you'll see the unemployment rate fall a little bit below 7 percent. But there still will be a lot of unemployed and underemployed people out there. We know one of the main reasons why the unemployment rate has come down is because we're at a 35-year low in the labor force. A lot of people of working age have left the labor force, and that's put downward pressure on the unemployment rate.
But we are seeing some improvement there. Companies are hiring people in a pretty broad array of industries. They're just not hiring a lot of people. The improvement has been broad but slow and will continue to be slow.
H.L.: How's the manufacturing sector look?
S.W.: Most of the regional manufacturing surveys have been positive and above zero, and that reflects expansion, but it's in a modest range. It gibes with our expectation of 2.4 percent growth in the Gross Domestic Product next year and a slow improvement in the labor market. So I think you're going to see an improvement in manufacturing, but, once again, it's not going to be a surge. It's going to be modest growth, expansion but not at a significant pace, and that's what I'd look for in 2014 as well.
H.L.: Business investment is slowing. What do you see happening there?
S.W.: I expect capital spending to also increase at a modest pace in 2014. Many companies have been holding back on capital expenditures. They've been afraid that the economic recovery is going to falter. They've been concerned that the dysfunction in Washington is not going to provide a lot of clarity in terms of taxes and regulations and things like healthcare costs, how much it's going to cost to hire an employee. Those will continue to be issues, but I think you're going to see better business capital spending in 2014.
A lot of companies have held off on technology spending, and one reason why we like the technology sector is because we anticipate some better technology capital spending next year.
H.L.: Exactly how bad is the situation in Congress?
S.W.: I think it's pretty bad, and I think we're going to see in this budget and deficit debate a string of continuing resolutions. So we're not going to get the solution we need. Most of what these elected officials would like is to kick this beyond the mid-term elections.
Washington has been a big problem, particularly for business, because they question what the new regulations and taxes are going to be. You don't know? You don't know what it's going to cost to hire more employees. Washington many times tries to extend things for a year, but if you're a business trying to make a strategic decision, you're looking out five to 10 years, and it's hard to do. You have no certainty beyond a year.
Washington is going to continue to be a problem, and the chances of Congress addressing our problems are slim to none. Our politicians act when there's a crisis, and we're not in a crisis, and I don't expect we will be in a crisis any time soon, so I don't expect any real solutions to these very important longer-term issues.
H.L.: Is the right track to cut the deficit more now, cut aid to poor families and children, keep taxes on the wealthy low, and not spend more to lower unemployment?
S.W.: We have the most progressive tax structure in the world, with higher wage-earners footing the vast majority of the bill. There's a lot more spending that needs to be cut. There's been basically barely any cuts so far. I think you have to do this slowly over time. I would certainly hope we would continue to see some sort of budgetary adjustments here that bring down the level of government spending.
In my mind, the sequester, however inefficient it was, was the only way to get any spending cuts. The government needs to figure out ways to spend less, and there are plenty of spots to do that.