John Manley

Don’t tread on me

AdvantageVoice® Blog—11-12-12
John Manley, CFA, Chief Equity Strategist
Let me tell you how it will be,
There’s one for you, nineteen for me.
‘Cause I’m the taxman…
And you’re working for no one but me.
– George Harrison, “Taxman”

I wonder how the “Quiet Beatle” would have reacted to last Tuesday’s election results; in my opinion, not as sharply as we did on Wall Street. But, then, he had firsthand experience with truly high tax rates and, I suspect, we will not. He played music, we play trump cards.

Since the re-election of President Obama, the S&P 500 has dropped almost four percent (about three percent if the inexplicable rise on Election Day is included). There are a number of proposed reasons for this decline, some of them politically charged, some of them not. In my opinion, it seems to be something of a market tantrum, not caused as much by the re-election of the president as by the prospect of governmental gridlock and a drop off the “fiscal cliff.” It appears that the “stock market enforcers” have to go to work again.

I had assumed we were beyond all this. With the announcement of the third round of quantitative easing (QE3), I thought the trading range might be behind us. European austerity seemed to be becoming less austere. China appeared to be on the mend. The American consumer remained open for business and even the American housing market seemed to be clearing. With investors still skeptical about long-term growth, open-ended positive monetary pressure for the Federal Reserve should have supported us until some sort of budget compromise could be adopted.

While I think that reasoning still makes sense,  it now appears that we investors may have to apply some more pressure to accomplish that last item, and that pressure may have to take the form of rapid (and, hopefully, short-lived) equity price declines. As the bond market’s intolerance of inflation ultimately defeated inflation 30 years ago, the stock market’s intolerance of delay in dealing with political issues can force the issue today.

Strategists must use current fundamentals to predict future stock market actions. Politicians have it easier; they get to use current stock market actions to predict future fundamentals. What happened to equity prices last Wednesday and Thursday hopefully sent a clear message about the future issues that will result if a compromise on taxes, spending, and the budget is not achieved. I am hopeful that the message was heeded, but am confident that it will be sent again and again if it was not.

With that in mind, we are adjusting our outlook for the S&P 500 for the next 14 months to a projected range of 1,300–1,600. We realize this is a bit broad, but note that the bottom end is our acknowledgement that an overshoot could occur if the market’s first warnings are not heeded. It would represent a nasty, brutish, and short correction of 10–15% from the recent high and serve to force the political compromises needed to avoid the fiscal cliff.

We suspect that all of this will be unnecessary. Quick corrections do not have to be deep to make the point. To demonstrate this, we are retaining our year-end 2012 target of 1,505 for the S&P. The point to be made is that the equity market has already forced progress on political issues around the world. We believe that it will do what is needed to finish the job. The only question is how much will have to be done to achieve this.

The views expressed are as of 11-12-12 and are those of Chief Equity Strategist John Manley, CFA, and Wells Fargo Funds Management, LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the author and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.


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