Interview With Wells Fargo's Scott Wren: 2012 Shaping Up as Crucial Year

by: Harlan Levy

Scott L. Wren is a senior equity strategist with Wells Fargo Advisors (NYSE:WFC). Previously he was Senior Equity Strategist with A.G. Edwards (AGE). He is often quoted in The Chicago Tribune, The Los Angeles Times, The Washington Post, and The Wall Street Journal.

H.L.: How much has international turmoil in Japan, the Middle East, the European euro countries, China, Afghanistan, and Pakistan affected the U.S. economy?
S.W.: So far, I don’t think it’s affected the economy that much. I think we’re still on a path of modest growth that is likely to continue for some time, but there is certainly a risk that those events could negatively affect the economy as we look out at the course of the rest of the year, largely because of higher oil prices.
It’s hard to predict what might happen in the Middle East and North Africa. The outcomes in a number of these countries are going to be different. Some may disrupt the supply of oil, and others may not. Libya may be back to pumping its normal amount of oil fairly quickly. The volume may be down 50 percent or more now, but that may remedy itself over the next few weeks or a month or two.
It’s hard to predict, but I think from my perspective, barring a huge spike in oil from current levels, the U.S. will continue to recover and grow at a modest pace. And we’re going to see a slow improvement in the labor market and some reasonably good corporate earnings growth.
H.L.: It feels like the stock market’s extreme gyrations can make you queasy — as well as lose the little investor a lot of money. What entities control the flow of stocks?
S.W.: The market has basically gone straight up with very few interruptions since last August. It’s been a very, very steep rise. Thursday was really the first day we had a significant pullback (followed by yesterday's morning plunge).
I think that retail investors who have missed a large part of the two-year rally which we’ve seen have been jumping into the market the last couple of months, which almost makes a minor pullback a high probability. When they start to pile in to stocks, that’s usually a pretty good contrarian indicator, and it just increases the probability of a minor pullback.
For most of the last two years it’s been institutional money that has been driving the market higher
— hedge funds, asset managers and those types of entities managing large sums of money, discretionary asset managers — because retail investors have been afraid to get back into the market.
H.L.: Where’s the stock market headed?
S.W.: Here’s what I think will be happening: We’ve been looking for the major indices to hit their 2011 highs somewhere around the middle of the year. Then we’re expecting them to fade a little bit in the second half, because I think there’s going to be a lot of headwinds.
One of those headwinds is that the Federal Reserve is starting to have conversations about and making public statements about raising interest rates, which I think will happen in 2012. The Fed has been trying to engineer some higher inflationary expectations, which they’ve done. That tends to put a lid on P/Es (price-to-earnings ratios) and at least a temporary lid on the market.
I also think we’re going to see some margin pressure as a result of hiring more workers as the economy improves, and businesses are also paying higher input costs, and that will result in a little bit of margin pressure.
One of the biggest headwinds is that we’ve had such a huge run in the last two years. At one point we were up 100 percent, and that’s a far bigger rally than anything we’ve seen in a recovery in any time over the last seven economic cycles. The magnitude of the bounce-back we’ve seen in the market has been greater than that after the early 1970s recession or the early 1980s recession.
That is a significant factor. We’ve come a long way in a relatively short period of time. The probability of having the market trade significantly higher in the near term is pretty low, I think. And at the end of the year the S&P 500 will be in the 1,250 to 1,300 range.
H.L.: What sectors of the market do you like and don’t like?
S.W.: We’re relatively early in this economic cycle, so we want to remain overweight in sectors that are sensitive to the ebb and flow of the economy. We like materials. We like industrials particularly.
We want to be underweight the defensive things like healthcare and staples.
If we have a minor pullback, the defensive sectors are going to outperform, but we’ll be looking for places to buy on pull-backs, and we want our clients to keep that cyclical bias in their portfolios.
H.L.: Are you saying stocks may be stuck for a while?
S.W.: After you have a big run in the recovery, and once you bounce off the bottom it’s very typical of major indices to trade in a fairly narrow sideways fashion for an extended period, before the second leg of a bull market starts. And we could very well be in that sideways period where the market may be up, say, 10 percent, but overall it’s dealing with rising interest rates and rising inflation. What will that mean for the economy and for earnings? Those are the questions.
Once we get comfortable with that and comfortable with the global recovery continuing, typically you’d get another leg up in a bull market. That’s going to happen, but I don’t think that’s going to happen in 2011.
H.L.: What about 2012?
S.W.: I think that some time in 2012 you could start the second leg up in this cyclical bull market. As the economy ebbs and flows, a typical economic cycle lasts for five to seven years, and the market reacts typically a certain way within that cycle. Initially the market starts to rally before the recession is over. Then after that first leg you tend to take a little bit of a time-out and adjust to what interest rate policies are going to be, and then growth continues at a reasonable pace, inflation stays at a reasonable pace, and the market feels good about that and does another up-leg of the cyclical bull. Usually the upswing is a multi-year period, and we’ve had two years so far, so we could see some economic growth for three more years.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.