John Manley

When will all of this end? It’s tough to be a bull in this bull market.

AdvantageVoice® Blog—11-4-13
John Manley, CFA, Chief Equity Strategist

“Tout passe, tout lasse, tout casse.” (Everything passes, everything tires, everything breaks.) French proverb

Yes, the French have a word for it—or, rather, a number of words for it. It is that existential languor for which they have been famous since the time of Rabelais, a sense of fatalism, a sense that nothing good can long endure. It is a very French and a very un-American idea.

And yet, that sentiment is much in vogue on Wall Street these days. While the equity market has cleared hurdle after hurdle to set new highs in the face of economic uncertainty and political stalemate, the consensus that sooner or later we will have to pay for the excesses of the past 30 years has endured. If anything, it has ripened into a sharper notion that all of the market’s gains in the past four years are ephemeral nonsense that will soon be sunk by the forces of a harsh reality.

So, let us address our fears: When will the bull market end, and what will end it?

I should say at the outset that I am not talking about a 5% to 10% correction. That can happen at any time—one price we investors pay to own a part of the future. Corrections might be inevitable, but I believe they’re far less problematic than trying to live on a risk-free return these days. The big question is what will set off the next 25% to 40% decline in stocks.

I think there are a number of possibilities, but none seem likely in the next 6 to 18 months.

The first—and historically the most likely—is that the Federal Reserve (Fed) adopts a restrictive monetary policy. This could be the premature withdrawal of quantitative easing or, more likely, a series of rate hikes designed to constrain robust and inflationary economic growth. The former is an unlikely mistake given the Fed’s view of the fragility of the current recovery. The latter may be an inevitability, but it is a very distant one, in my opinion. There appears to be ample capacity to dampen inflation for the time being. The use of that capacity would imply a period of economic growth that could push sales, earnings, and stock prices higher in the interim.

The second risk is that sales and earnings decline sharply without prompting from the Fed. This happened in 2002 and 2008, but again, such a scenario seems unlikely to me. Profitability numbers are high by historical standards, but they have been high for some time. Profitability has confounded the skeptics by not only failing to fall but actually pushing grudgingly higher. Past peaks coincided with strong economies, which is not at all the case today. I think that efficiencies—not booming economies—are driving profits and profitability today, and while these may ultimately be arbitraged away, that is going to take enough time to frustrate the doomsayers in the intermediate term.

The third risk is that valuations are too high and will collapse of their own weight. I doubt it. Valuations on future predicted earnings are still below the average of the past 20 years. I think that they already reflect fears mentioned above in the second risk and could be pushed higher if the anticipated earnings cataclysm fails to materialize on cue.

Finally, there is the risk that something unexpected comes out of the blue to undo us all. I can’t answer that one, but given the baldly speculative nature of the argument, I’m not sure I should have to.

The views expressed are as of 11-4-13 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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