Stuart T. Freeman is managing director and chief equity strategist for Wells Fargo Advisors. Previously he was chief equity strategist at A.G. Edwards & Sons Inc.
Harlan Levy: What's your take on what's happening in the euro zone?
Stuart Freeman: Obviously, there are a lot of decisions and behaviors to come. The Greeks have an election in June. A lot could happen over the next three to five weeks. It's not out of the question that Germany makes some noises that it will provide a little room for Greece in some way. It's a very fluid situation both short-term and longer term.
Our strategists feel that there's as much as a 40 percent chance in the next six to nine months that Greece will leave the European Union, and longer term the odds could be even greater. The real question is what Germany might do to push things off a bit.
If Greece leaves, the question is what does that mean for other countries that may decide that that is also their path. Investors in those countries would have to watch to see what happens with Greece.
H.L.: What are the possible scenarios?
S.F.: If Greece decides to bow out, the short-term impact on markets would not be positive and more negative on European markets than the U.S. We would probably continue to see more strength in the U.S. dollar and a capital run towards the U.S. We'd see more demand for U.S. Treasuries. And a stronger dollar is not particularly good for large-cap U.S. company earnings. You can make the case that Greece on its own would not have a dramatic impact on the entire world economy, but the uncertainty would increase that Italy and Spain are the
significant ones that would go next, and the markets would take that consternation to another level.
If Germany starts to make some noises that it would put up more capital, or as a group the European Union puts austerity off somewhat, the market that would benefit the most would be European markets. They would outperform, because European developed country stocks have been heavily sold off with emotion. The U.S. would bounce as well but underperform. The market has been worried about this for several years, and volatility will continue to be the issue probably through the fall. Also, it appears that Chinese lending growth is slower than expected and Chinese growth may be decelerating, which would add to market volatility.
H.L.: What about the U.S. economy?
S.F.: That's the other issue - that we're growing here at a moderate pace. That results in somewhat more volatility, because small events and changes in the worldwide economy have a larger impact on the domestic economy and perceptions when the economy is growing at a below average pace. It's like when you ride a bicycle very slowly. You've more likely to fall over from a small impact.
We're looking at the U.S. economy growing at a 2.5 percent rate for Real GDP for this year, which is favorable versus many other economies but more vulnerable to external shocks.
On the positive side, we are growing if modestly. We are seeing modest job growth. We are still seeing a slow decline and softening in jobless claims, which is a leading indicator for job growth. We're in an environment where because of lower demand and favorable supply, energy prices are drifting downward. Also, despite the fact of international uncertainty, consumer confidence is near a four-year peak And if you look at the growth across the economy, it's somewhat broad across multiple industries, not just in one or two areas. That means a larger portion of the population is in some way either personally or peripherally noticing some changes and some growth.
It also looks as if we have some disinflation working, probably through the end of the year. The softening in energy prices is a positive for consumers, acting like a tax cut, and it's positive for companies and their costs. We are seeing weakness in energy in part due to a sufficient supply of natural gas here as well as slower demand internationally. The drop in energy prices that has just begun will take some time to show up in spending practices and in profitability, but it will.
H.L.: What about housing?
S.F.: It's a multi-year issue that we're working through. The banks are still working through foreclosures, and, depending on what market you're looking at, home sale volume seems to be stabilizing. It's less clear that pricing has stabilized. We're still in an environment in which home owners and consumers are deleveraging. While they're cleaning up personal balance sheets home prices are likely to remain under a ceiling until you start to see a floor in existing home sales and a pick-up in volume, a leading indicator for pricing to pick up.
There's a good chance that in the next year or so we might see volumes pick up, although it might be multiple years before we see significant price increases across the nation.
H.L.: What do you see ahead for the stock market?
S.F.: We're still in the back end or near it of a volatile sideways-moving market that is typical after you get your first leg up in a cyclical bull market. We had about a 100 percent move in the S&P 500 from its low in March 2009. That was the first leg, which tends to be the strongest leg in shifting from recession to "maybe we're
getting better."
It's very common after that occurs to have an uncertainty period where investors wonder if the growth is sustainable, if they should take profits, what the central banks will do next, and what will happen with jobs. Last year we felt we were full in that phase, and our weightings were more balanced, overweight some defensive groups and underweight some cyclical groups. We spent some time overweight utilities and overweight telecom. We were heavily underweight health care and heavily underweight consumer staples, expecting recovery.
As we entered this year our thoughts were that we're probably building a base and moving toward the second leg of a cyclical bull market. It's very possible that that second leg actually may have started in the fall when investors were very concerned about a double dip and the S&P 500 hit 1,075.
As we move ahead we continue to see growth ahead, jobs growing slowly, consumer confidence growing slowly, and consumer spending growing. We think we'll also see a lift in investor confidence, which in recent
periods has lagged consumer confidence. And we think we'll see the potential of some moderate price-to-earnings expansion as we move into the later part of this year and into next year.
We estimate 6.8 percent growth in operating earnings for the S&P 500 for this year after 15 percent last year. We also see a possible valuation rise later this year and into next year. We've increased our target for the S&P since last November to 1,400 to 1,450 at the end of this year. We've increased it in the last five or six weeks, because we're seeing more leading signs that suggest that confidence can continue to grow into late in the year and into next year.
Because investors mistakenly anticipated a double-dip recession last year, we had a sell off. Then some of the recovery fell into early 2012, and we inherited some return from last year, so it might not be out of line to expect an 11 to 15 percent return this year, with some of it just borrowed from last year.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AAPL over the next 72 hours.
