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John Manley

The Archduke and the black swan

AdvantageVoice® Blog—3-25-13
John Manley, CFA, Chief Equity Strategist

“One day the great European War will come out of some damned foolish thing in the Balkans.” Otto von Bismarck (1888)

There you go again.” Ronald Reagan (1980)

Every equity strategist wants to be Nostradamus, but, in this case, I think they would settle for being Bismarck. There is that deep-seated desire to be the one who correctly makes that big, big call—the one that so many missed, the one that’s a career maker. I guess the baseball analogy is swinging for the fences. The difference is that strategists can aim for the bleachers but check their swing at the same time.

The trick is to say it but not predict it. Something could happen. Something is possible. Something reminds you of something. Get yourself connected with a plausible but improbable outcome (preferably one that the investing public deeply fears or desires) and then play it by ear. If it happens, you said it. If it doesn’t, you didn’t predict it. For this strategy to really work, however, you must hit on something that resonates with a preexisting belief in the investor subconscious.

Knowing that, I probably should not have been surprised by what I heard last week. I heard three televised strategists say that Cyprus reminded them of the event that triggered World War I, the assassination of Archduke Franz Ferdinand (in the Balkans!). Mind you, they were not predicting a catastrophe, but they wanted you to know that, less than 100 years ago, a seemingly minor event on the periphery of Europe had led to one…and only Bismarck and they had raised the possibility. 

They did not reference any of the many events that had occurred in Europe in the last century that had not proved to have cataclysmic consequences. They also failed to lay out the layers upon layers of assumptions and contingencies that would have to be true in order for another World War I to occur. It’s easy to say something reminds you of another thing. It’s hard to say why they are the same thing or why they will lead to the same result.

I am being cynical and more than a little too flippant. There are serious issues being raised by the developments in Cyprus. Just to assuage your fears a bit, I’d like to point out that one of the ways in which the assassination of Archduke Ferdinand led to the Great War was because of competing alliances in Europe. If I had to point to the one thing that is different this time, it would be that Europe, especially the eurozone, is one big alliance. 

Things could get much worse—not only in the Mediterranean but also in continental Europe, South America, China, and the United States. (For a better discussion of these smoldering fires, I recommend an excellent article by my colleague Brian Jacobsen). If nothing else, the stock market is up, the dollar is up, economies outside the U.S. seem to be slowing down, and earnings preannouncement season is upon us. All the ingredients for an air pocket are there.

Still, if U.S. stocks break to 1,500 on the S&P 500 Index, I think it would be a buying opportunity. Stocks are not expensive, and the Federal Reserve (Fed) has promised to stay friendly, at least until some or all of the above-mentioned problems are positively resolved. Fed policy is not the only causal factor of stock market performance, but I think it is the most important one in the intermediate term. Moreover, I think that investors still harbor the dark consensus that sooner or later something bad will get us, an unfocused dread that has lingered long after the great bear market left us four years ago. Pressures to abandon the barren world of risk-free holdings may have recently dulled the fear, but, in my opinion, they have not destroyed it. The fact that some feel free to speak of extremely negative outcomes without fear of ridicule is evidence that the Age of the Black Swan has not passed. As long as the worst outcome can easily be brought to mind, the duration and depth of an equity correction is likely limited. Those who fight the Fed may win a skirmish or two, but the war is a different story.

The views expressed are as of 3-25-13 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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