Wells Fargo strategist Wren says market to stall on DC gridlock, but this strategy will still work

Published Tue, Feb 14 201712:22 PM EST

Overall equity returns this year could stall in the months ahead as investors temper their enthusiasm around the speed of economic reform promised by President Donald Trump, which is likely to take time, according to Scott Wren. "I think the new administration will have very little to do with what happens in the economy in 2017. It's more of a 2018, 2019, 2020 story. And that's what we're trying to talk to our clients about," said the senior global equity strategist for Wells Fargo Investment Institute. "Many of them, those at least that were enthused with the result of the election, keep thinking, '4 percent growth, 5 percent growth,' they keep hearing these big numbers. And we're telling them that that's not going to happen. This is going to be a modest growth, modest inflation year," he added. Wells Fargo Investment Institute serves clients of the company's wealth and investment management division, which has $1.7 trillion in assets. In this exclusive strategy session, Wren sits down with CNBC's Mike Santoli to explain how the firm is advising clients to beat subpar market returns and position themselves for growth this year. Some of the topics covered include: The market dynamics that could derail the rally. Whether investors should look for growth overseas. His favorite investment ideas for 2017. The one mistake retail investors have made since 2009. PRO subscribers can also read the entire transcript of the exclusive interview below. (Editor's note: The content below is from a third-party service and there may be some minor transcription errors. Watch the video for the exact quotes.) MIKE SANTOLI: Scott Wren is senior global equity strategist for Wells Fargo Investment Institute, a subsidiary of Wells Fargo and Company, where he produces strategy and guidance on global equities. Prior to joining Wells Fargo advisors' predecessor firm, AG Edwards in 1998, Scott worked as a senior foreign exchange dealer for Boatmen's National Bank of St. Louis. He began his career on the trading floor of the Chicago Mercantile Exchange and has more than 30 years of experience in financial services. He's a graduate of the University of Kansas and holds a master of finance degree from St. Louis University. And he joins us here at the NASDAQ in a snowstorm, to give us an idea of where you think markets are going. Scott, good to see you. SCOTT WREN: That's right, we picked the perfect day to come to town. MIKE SANTOLI: It's ideal. I'm glad you made it to the center of Manhattan on this day. So let's just situate ourselves for the markets here. As we've started this year, we've had a pretty eventful, in terms of news flow, three months. The markets have rallied up to a point, paused. What do you think both the potential is for this market and what are going to be the catalysts? We keep talking about it as if it's a fiscal, policy-driven story, but is that? SCOTT WREN: Well, I think it could possibly be a fiscal policy story. But I don't think that that's what got us to this point. I think that people were a little nervous going into the election. The result was unexpected. The market I thought was going to trade down for maybe a period of several weeks, but we felt very good that by the end of the year we'd be in that 2190, 2290 range for the S & P 500. That was said earlier in the year and was not based on who was going to be president. So first of all, I would argue that whether Hillary Clinton would've won, or obviously Donald Trump did, the market would be trading right now pretty close to where it is. I really don't think that, at least based on our work that there's a big Trump premium built in. We know what might and could happen. We don't think it's going to play out in 2017. I think the new administration will have very little to do with what happens in the economy in 2017. It's more of a 2018, 2019, 2020 story. And that's what we're trying to talk to our clients about. Many of them, those at least that were enthused with the result of the election keep thinking, "4% growth, 5% growth," they keep hearing these big numbers. And we're telling them that that's not gonna happen. This is going to be a modest growth, modest inflation year. MIKE SANTOLI: If, as you say, you don't necessarily need to reach for specific Trump-related policies or electoral dynamics to explain why the market is here right now. What has gotten us here? What were you looking at earlier last year that said fair value is going to be about where we finished up the year? Obviously you have an earnings rebound, you obviously have also some pretty decent global indicators in the last several months. SCOTT WREN: I think really all of last year on a quarter to quarter to quarter basis, the market knew that earnings were going to be terrible last year and certainly that the energy sector was going to be the big anchor. And really I think what investors wanted to see was just gradual improvement. Less bad, so to speak, every quarter. And of course in the fourth quarter, earning were pretty decent and continued that progression of improvement. But the market all last year, really from January, February on, was trading off of what they anticipated, what investors anticipated for 2017. Our group felt that we'd have much better earnings growth, or at least reasonably better earnings growth. Better GDP growth. Now, great GDP growth? No, but slightly better. Not only here domestically, but abroad as well. So I think valuations were not stretched. And when that election was over, it was almost a relief to get through that and it allowed the market to trade to the fundamental spot where at least we felt it should be. If you look at something, evaluation parameter like a price-to-earnings ratio, 16.7 times over the last 30 years in the S & P 500. We're at about 18 now, low inflation environment. I think the market's done a good job of not pricing in too much of what might and could happen down the road. MIKE SANTOLI: Where does that place us, do you think, over the course of this cycle. Because I feel like one of the things that maybe has gotten a little bit hard to decipher or confusing for a lot of people is all the all the talk, as you mentioned, of the election. And suddenly there's going to be this renewed policy set up. And there's going to perhaps be this new push toward growth. But this cycle's been going for a while. We're eight years into an economic recovery, just about and a bull market. And the credit cycle's been going. So all these things have been in motion for a while. It's not as if we necessarily reset to zero just because we have a new angle in the White House. SCOTT WREN: That's right. And really once again we would've argued that whoever was president in their first term, there's a pretty good probability there would be a recession. As you mentioned, we're eight years in. Average expansion over the course of the last eight years is four and a half years. So if time is your criteria, this one's a little long in the tooth. So I think that that is a consideration and part of the reason it's been able to last this long is because we've been growing 2% pretty steadily. We haven't had that ebb and flow. The fed hasn't had to come in and shut things down or do anything like that. So I think we're at a point in the cycle where we're certainly in at least the seventh inning, if we want to use a baseball analogy. We have more baseball to be played. This is likely a stall year for the S & P 500 this year. But we're not calling an end to the cycle. And we want to lean towards those sectors that are still going to benefit from a continuation of the cycle. And if some of these proposals are implemented and in enough magnitude to keep the ball moving forward, then we could see this thing extend for a few years. So that's the way we're looking at it right now and I think that's a pretty high probability event. Not that we get 3-4% growth this year, next year. But we'll next year maybe get to 2.5, 2., maybe 3. Market would be very happy with that if inflation stays reasonable. MIKE SANTOLI: Well, it's interesting you say, "If inflation stays reasonable," which most likely it will. But inflation perhaps can be a bit higher than it has been. So that maybe in a more comfortable zone toward the targets that the Fed wants to take. And so in a way the stock market doesn't mind seeing nominal growth go up. Right? Even if real growth is in the 2s, if you have that 2% inflation on top. We report earnings in nominal terms. SCOTT WREN: Right. I think the stock market would like inflation that is moving up, interest rates that are moving up in an accelerating economy. If inflation and interest rates move up and we grow 2%, that might not be so good. So I think that's the situation. But that accelerating economy, I think what we really want our clients to think about is it's not this hype level of growth. You might see that a quarter or two somewhere along the way in the next three or four years. That's not going to be a consistent rate of growth, 4%. MIKE SANTOLI: When you say you're expecting something like a stall year for the S & P 500, so it just kind of trades around this zone, do you think for most of the year? SCOTT WREN: Based on the work that we're doing, and this year we have a 2230 to 2330 target range. We're right in the middle of it, a little bit north of the middle of it right now. Our work suggests that you're going to see that high somewhere in the middle portion of the year. May, June, July, something like that. And then we trail off a bit in the second half. We expect the highs to be at maybe slightly above the top end of our range. Somewhere around that 2330, a touch higher. But then the headwinds for the second half, at least in our opinion, is wage pressure concerns in 2018 or the potential for that. And also the potential that would play into that is, is the Federal Reserve behind the curve. And so for us, that's the second half headwinds and that's what's going to net-net make this year relatively flat and nothing to really get excited about. MIKE SANTOLI: So you're likely to see at least some kind of scares along the way about whether the Fed's gonna have to move more quickly or not. SCOTT WREN: If you think about an employment report, the most recent employment report that we had out. Average hourly earnings, which I think is the most important number in each of these reports and certainly has been for the last nine months, dropped to 2.5%. The market was expecting a 2.8 or 2.9 number. Fed would love to see it at 3 or 4%. So I believe this last push we've had in the market was due to that. The market is really going to start to tune in on that wage number. And that is what I think is going to drive those second half concerns. 'Cause I do think, based on our work, that you're going to see a little bit of wage inflation and at least some fear that it's going to accelerate in 2018. MIKE SANTOLI: You mentioned that you like to play those sectors that can take advantage of this latter stage of a cycle. If you're getting wage pressure, does that include things that benefit from a stronger consumer? SCOTT WREN: It does. The consumer discretionary sector. We like the financial sector. We like industrials. Those types of things we had been overweight technology. Technology's moved all right, we've backed off of that. But still even in an even weight in technology, you're talking more than 20 percent of your equity portfolio. So that's still a pretty good load. We don't want our clients hiding. We don't want them consumer staples, utilities, things like that. And I will mention energy. We are underweight energy. There's a couple reasons for that. We keep getting questions about that from our clients because they keep hearing a lot of talk about energy and energy independence. The problem with that, at least from our point of view, is that industrial companies will benefit from the infrastructure that we need to build to get energy independent. I feel confident that we could do that over a five or seven year period. The problem is we bring more oil onto the market. Oil's a globally traded commodity. It pushes prices down and these energy stocks are not going to respond well to a lower energy price. Particularly drillers, exploration and production, those type of industry groups in energy, very sensitive to the price of oil. I think oil, our commodities team looks at 55 to 60 as the high. They want to be underweight commodities. We like it. It jives with what we're thinking in terms of energy stocks as well. MIKE SANTOLI: It's interesting, you talk about consumer discretion. I feel like people hear that and they immediately think retail. And in fact, pure retailers are a relatively small piece of consumer discretion. You have media in there, you have autos, other things that benefit from consumer spending. Do you distinguish among where it makes most sense? SCOTT WREN: Well, I think it's certainly some of the brick and mortar type of retailers that are having a tough time getting their internet act together, which there's numerous ones of those. I think that is going to continue and they're going to continue to lose business to those that are able to do things better over the internet. The consumer discretionary sector has been the best performer since the March 2009 lows. A lot of people think that's a surprise because we've been in a relatively slow growth economy. But it's done well. And if you think that the labor market is going to continue to improve slowly, which we do. If you think that wages are going to slowly rise, the wage pressure, which we do. The consumer still has legs and I think that this could play out even longer than it already has. MIKE SANTOLI: What about the global picture. The U.S. has outperformed most markets really by a pretty profound degree for a while now. People look and say, "Wow, Europe looks cheap." But it seems like there's so many issues that you have to worry about. Merging markets have had a little bit of a comeback. Where would you be advising clients to look? SCOTT WREN: If you look at developed international and emerging international, emerging is still tied to China. They're tied to the growth of the rest of the world. And let's face it, stability, a little bit better growth. But I think that is still going to be a problem for the emerging markets. Also the dollar is a little stronger. We don't expect it to gain a lot ground. We would expect dollar-yen to be a little bit higher than it is right now. The euro is about where we think it's going to be. But certainly a stronger dollar is not always good for the emerging markets. That's a problem. I think those stocks relative to ours, if you look at something like a price-to-earnings ratio, they're definitely cheaper, quite a bit cheaper. But I think there's a reason for that. As far as the developed international, if you look at the euro zone, 1.3, 1.4% GDP, which we don't think is very good, but is actually halfway decent for them. But I think there's a lot of problems over there. Those stocks also on a valuation basis look cheaper. But I think there's a lot of issues over there, not just political ones. There's debt related ones. We certainty obviously have a lot of elections and important ones coming up here. We know that Britain is going to be leaving the E.U. Could easily not be the first country to do that. So I think there's a lot of issue over that are a headwind to growth, a headwind to confidence. But from where these markets are now versus the S & P 500, I think they'll trade, they'll be flat slightly changed on the year. We're even weight all of those right now. MIKE SANTOLI: Gotcha. You mentioned a couple times that you've had certain points you were accentuated to clients. You don't want them hiding in these defensive sectors. Or you're trying to maybe restrain some of the optimism about how fast the U.S. can grow. Are there other big issues that you feel like you're constantly reiterating with clients? In other words, are they worried about what they're gonna do with fixed income? Or what does it mean if rates are going up right now or anything else? Or for that matter, have you had to continually make the case to get people's equity allocations up over these years-- SCOTT WREN: That is exactly the case. And Mike, we've fought that battle really since the '09 lows. And retail investors, they've had a lot cash on the sidelines. They've been hesitant to get in. We have been pounding the table for six years on every pullback, step in, step in. Because our client in general, and I think you can say this generally for other retail clients, or just retail clients out there. They've been under-invested in stocks. They've been very fearful. They've been thinking that the next recession is right around the corner. And so that has been the biggest battle that we've had is to get clients invested. We've had conviction in our outlook. We want them to feel good about that, but that's easier said than done. And I will tell you that we've had, and I can't say it's completely surprising and I think you'll agree. But since the election and the market trader higher, we have more clients that are more interested in the market. Now have they put their money where their mouth is? Some have. But the money is trickling in. No one's jumping in, no one's chasing the market or anything like that. So the biggest battle for us has been equity exposure and having clients really take advantage of the opportunities that are out there. MIKE SANTOLI: Do you feel as if you would be as vociferous about making that point today at this level, at this point in the cycle. In other words, you tried to probably tell them in 2011 when the S and P was trading at 12 times earnings or something to get back in. If they didn't 'til now, do you have to say, "Look, just be more careful about it?" SCOTT WREN: Right now, to be honest with you, I'm hoping for a pullback. If we saw 5% or 7% pullback, it certainly wouldn't change our opinion about what's likely to occur over the next couple of years. So pullbacks are good when you're at fair value. We haven't really had many of those. We've had one that was actually playable at the beginning of 2016. The other two, I would argue, they came and went so fast that you just couldn't do anything. I think that going back to my trading days, if you have x amount of cash to put in the market, I would have no problem even here at the highs or near the highs, put a third in now if your outlook is anything other than the next five months or six months. And then if we do get some kind of pullback, you have to have a plan and you have to be willing to step in. And I don't think we're going to see a big pullback at any point this year. As I said rally into the middle of the year, come down a little bit off of there. But to think that we're gonna have a ten-plus percent pullback from here, right now it just seems unlikely unless there is, as always, some event out there that's unforeseen. I don't think it's going to be because the U.S. economy crumbles or the global economy crumbles. I don't think any of that is going to play into it. MIKE SANTOLI: Uh-huh. And just finally, would there be other risks aside from those real fundamental economic ones that you feel as if could knock things off course? We keep talking about the perceived volatility of this administration and they're kind of being a little fitful about how things are getting going in Washington. And the markets have no problem shrugging that off to date. SCOTT WREN: The market has not shrugged it off. I always think there's always possibilities out there. Chinese growth comes in in the 5s. Euro zone growth comes in at 0.5. I think those are risks to the global economy and let's face it, we need some help from the global economy. But I do think that from the new administration, the risk on our side is that we are calling for this relatively flat market, calling for a stall market. But let's say some of those proposals get through quicker than what we think in a magnitude that's enough to affect the economy sooner than we think and we're too conservative. That's why I say we want our clients to lean towards those sectors that will benefit if we're wrong. Would we have liked to have been leading a lot harder? Absolutely. But I think for us, the risk is not necessarily to the down side from the administration, it's that we're underestimating the speed at which they can implement these policies. MIKE SANTOLI: Sure, yup. Upside risk exists too. All right, Scott, thanks very much-- SCOTT WREN: All right. Thanks Mike. MIKE SANTOLI: For CNBC Pro Talks I'm Mike Santoli. Transcript by Transcript Associates, Inc.

"I think the new administration will have very little to do with what happens in the economy in 2017. It's more of a 2018, 2019, 2020 story. And that's what we're trying to talk to our clients about," said the senior global equity strategist for Wells Fargo Investment Institute.

"Many of them, those at least that were enthused with the result of the election, keep thinking, '4 percent growth, 5 percent growth,' they keep hearing these big numbers. And we're telling them that that's not going to happen. This is going to be a modest growth, modest inflation year," he added.

Wells Fargo Investment Institute serves clients of the company's wealth and investment management division, which has $1.7 trillion in assets.

In this exclusive strategy session, Wren sits down with CNBC's Mike Santoli to explain how the firm is advising clients to beat subpar market returns and position themselves for growth this year.

Some of the topics covered include:

The market dynamics that could derail the rally.
Whether investors should look for growth overseas.
His favorite investment ideas for 2017.
The one mistake retail investors have made since 2009.

PRO subscribers can also read the entire transcript of the exclusive interview below.