John Manley

It’s different this time

AdvantageVoice® Blog—1-22-13
John Manley, CFA, Chief Equity Strategist

When my information changes, I alter my conclusions. What do you do sir?” John Maynard Keynes

“Prophecy is the most gratuitous form of error.” George Eliot

“It’s different this time” are, perhaps, the most infamous words in the history of investing.  They have been invoked to justify purchases at tops and sales at bottoms since time immemorial.  Their very mention now provokes nodding heads and knowing smiles in investment circles.  The phrase has become the great unmentionable on Wall Street.

I am aware of this, but I think that the conventional wisdom is wrong.  Since the future is hard to predict accurately, I believe a proper understanding of the present should be the goal of anyone making investments. The gift of second sight may be needed to see into tomorrow, but putting current events in their proper context could provide us with some clues.   In my opinion, one of the most important keys to successful investing is to notice differences from historical analogies before others have and to act on them before they do. 

Predicting that things will be different in the future may be self-delusional at best and downright dangerous at worst.  However, noticing that something is different from historical precedent is both possible and vital to one who is trying to divine future events.

To me, the most recent example of this is the state of corporate profits.  It is quite proper to look at profitability measures for U.S. corporations (such as margins, profits as a percent of gross domestic product (GDP) as well as returns on equity and investment) in an historical context and to note how high they currently are.  All are well above normal and most are at or near record highs.  One could be forgiven for believing that these measures “must” soon decline.  Things do revert to mean from time to time.

However, while I believe such analysis is not inaccurate, I also believe that it is incomplete.  It must be remembered that the dates that marked peaks in stocks prices (and preceded significant decline in corporate profits), such as 1929, 1966, 1980 and 2000, were preceded by strong economic growth.  Generally, unemployment was low, capacity utilization was high, and growth prospects appeared to be vibrant.  Strong profits had been helped by strong economic growth, in my opinion. 

I believe that this stands in strong contrast to the current situation.  Economic growth has been stuttering and the recovery from the problems of 2008 has been sluggish.  I find it hard to believe that recent profit growth has had the same drivers as those that drove us toward “peak” profitability.

I believe that the current experience has been occasioned, not by strong cyclical growth, but, rather, by more subtle occurrences such as lower interest rates and efficiencies brought about by the implementation of technology.  In my opinion, the cyclical kick to profits that has marked other peaks has not yet occurred. 

If I am right, that implies that prognostications of impending profit declines may be premature.  I believe that many investors expect—or, at least fear—profit problems.  If these expectations are unfulfilled, I still see that chance for positive earnings surprises and consequent improvements in stock prices.

The views expressed are as of 1-22-13 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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