John Manley

Two old tales from Wall Street’s past

AdvantageVoice® Blog—4-22-13
John Manley, CFA, Chief Equity Strategist

“The dogmas of the quiet past are inadequate to the stormy present.” —Abraham Lincoln
“Everything old is new again.” —Peter Allen

I know that nothing ever happens exactly the way it did before. Times change. However, it seems to me that, in our business, once the conventional wisdom has decided that the old rules don’t apply, they can and often do.

It was that way with monetary pressure and the role of the Federal Reserve (Fed) in driving the equity market. Anyone who traded stocks between 1985 and 2000 learned that “you don’t fight the Fed.” If you looked back at the second half of the 20th century, you could find a tight correlation between Fed monetary policy and equity market direction. When the Fed was pursuing an expansive monetary and economic policy, stocks rose. When the Fed tightened, stocks fell. It was a much better fit than earnings, and we greeted the millennium sure of its efficacy.

Then it didn’t work anymore. Between 2000 and 2003, the Fed pushed and the stock market fell. Again, between 2007 and 2009, as financial chaos overwhelmed extremely positive Fed monetary pressure, stocks went painfully lower. The old rule seemed dead for a few years; then it wasn’t. From mid-November 2012 through mid-April 2013, both Japanese and American equity markets surged as their central banks pushed liquidity into the system. For a while, at least, it seemed as if the old rule ruled once again.

With that thought in mind, I thought it might be a good time to review some of the old saws that I learned as a rookie on Wall Street, one-third of a century ago. Here are two of them:

  1. Sharp pullbacks in stocks after protracted rises are usually corrections in a continuing bull market, not the beginning of major declines in prices. Let us hope that was true of last week’s action. I must say that my market memories coincide with this. I seem to remember bull markets slowly exhausting themselves at tops and rolling over. I remember quick and nasty corrections on the way up, just enough of a shocker to bring out the concerns that still lurked beneath the surface. Obviously, my memories (and any rule for predicting the future) are far from perfect, but that is what they are.
  2. Bull markets begin with noncyclical (early cycle) stocks leading the way. Market rotation then follows with early (consumer) cyclicals taking the lead. As time progresses, the leadership then is handed off to heavier (industrials) cyclicals and, finally, commodity stocks or inflation plays. This was supposed to reflect (or anticipate) what was going on in the real economy as Fed stimulus initially pushed equity prices higher and eventually induced economic recovery, expansion, and then high-capacity utilization and inflation. Today, the conventional wisdom is that it will not work this way. Investors know that this has not been an ordinary cycle and see no reason for it to become one. Few of them see accelerating growth on the horizon; many worry that growth is unattainable. They worry that the outperformance of the early-cycle stocks in the past four months is proof that the Fed will fail in its attempts to ignite a recovery. In a perverse way, however, this makes me wonder if the old rule has not returned. Remember, rising stock prices are a function of minds changing, not remaining static. Perhaps it was doubt and the conquest of doubt, which made old-fashioned rotation work the way it did.

We shall see. Everything is always different. But, perhaps, we should at least remember how things worked in the past, especially considering so many investors believe that the old rules no longer apply.

The views expressed are as of 4-22-13 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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