Darrell Cronk, President of Wells Fargo Investment Institute puts market volatility into perspective and provides ideas for how to stay focused on investment goals.
Darrell Cronk: There’s a wonderful quote that I have always loved, “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and can die in euphoria.”
Laurie King: That’s Darrell Cronk; he’s our guest this week. I’m Laurie King, and you are listening to On the Trading Desk®.
This week we hear from Darrell Cronk, President of Wells Fargo Investment Institute. He’s Chief Investment Officer for Wealth and Investment Management, a division of Wells Fargo and Company. Darrell, welcome to the program.
Darrell: Thanks for having me on your podcast, Laurie.
Laurie: And now I’d like to ask you, Darrell, to help our audience understand a bit more about the Wells Fargo Investment Institute.
Darrell: Sure, Laurie. The Wells Fargo Investment Institute was created to provide insights and research to individual clients, institutional clients, and corporations around things like asset allocation strategy, equity outlook, fixed-income outlook, commodity prices, and how to think about alternative investments within portfolios.
Laurie: So that’s who Darrell is. But let me tell you why he’s here. In times of market volatility, market psychology sometimes takes center stage in the minds and lives of investors, and that can nudge investors away from their investment objectives and goals. Darrell’s here to help us look beyond market volatility. Darrell, you wrote a post for our blog, AdvantageVoice®, dated February 2. It was a prescient article in retrospect where you indicated that we may be overdue for a correction of 3%, 5%, or 10%.
Laurie: That said, Darrell, this correction that we’ve experienced in early February, a surprise or not a surprise?
Darrell: It’s a great question, Laurie. I would say not a surprise. But it has been a little bit of a shock for investor psyche. The S&P returned 7.5% through the first four weeks of 2018; it was the strongest January start we’ve had in many years—basically since 1987. And surprisingly, in the month of January, the realized volatility was the lowest we’ve experienced since 1967. That has suddenly changed here in February, and so I think it has gone a little ways to having investors wonder, where do we go from here?
There’s a wonderful quote that I have always loved, one of my favorites, Laurie, from Sir John Templeton, one of the famous investors of all time that says, “Bull markets are born on pessimism, grow on skepticism, mature on optimism and can die in euphoria.” We certainly don’t think we are in a full-on euphoric state yet, but we may be seeing, in January, some early signs of that, and I think February is squaring those positions now.
Laurie: Let’s discuss some of the whys—looking beyond investor sentiment. Were there valid, fundamental reasons for the equity market sell-off?
Darrell: Yeah, there really was—an abrupt rise in interest rates, some building concerns about more inflation, and potentially more hawkish Federal Open Market Committee comments (or the Fed comments), have really created a short-term equity market tantrum that now has the Dow Jones Industrial Average and the S&P 500 in full correction territory.
We are watching that closely, and we think that you could see a little more volatility in that regard, but it’s important for investors to understand that, on average, we witness 5% corrections about three times every calendar year and a 10% market correction about every 11 months, or almost once a year. So we’re right back to where we should be, probably, in what I’d call “normal volatility,” and we just experienced a long period of time where we didn’t have hardly any volatility.
Laurie: So are fundamentals still solid for U.S. equity markets, do you think?
Darrell: Yes, I do. Several key factors are contributing to a favorable, fundamental backdrop. Improving economy and the tax overhaul should drive stronger domestic corporate revenue and earnings growth. We don’t see the signs for a recession in 2018. We do expect inflation to trend mildly higher this year, consistent with moderately higher bond yields. But it’s still a relatively benign factor overall for equity prices.
Current exchange rates put the U.S. dollar in a weaker position than it was certainly even a year ago, and that supports multi-nationals in revenue growth and earnings. We do see some cross-currents for the dollar going forward, but it should prevent strong depreciation or appreciation from today’s levels, based on our current analysis.
Laurie: So is there still room for equities to move higher then, do you think?
Darrell: Yes. We do believe that the latest pullback is more of an opportunity for investors who either may not have their full equity position. We know that institutional investors, corporations, and households still hold a significant amount of cash positions on their balance sheet and have been under-invested, largely, in the equity market through much of this recovery.
We think that continues to pose opportunities. We do tend to think late in the cycle or later in the cycle, that sectors of the equity markets that are able to drive top-line revenue growth should fare better late in the cycle. So that would be places that things like consumer discretionary, financials, industrials, healthcare, all can probably support their own top- line revenue growth and are indexed well to an improving economy in 2018.
Laurie: Darrell, let’s also talk about practical ways investors can reframe their thinking as we move forward.
Darrell: Yeah, there are a number of things I think investors need to keep front of mind in these types of corrections. Number one, do maintain a modest cash position. You always want to have some “dry powder” if you will, to be able to put back to work. Because you don’t know exactly where equity markets will correct to or how low they could go. So having enough cash available to manage your day-to-day expenses, so that you don’t have to sell longer-term assets into market weakness is important.
We do think that it’s important that clients think more defensively about their fixed income. We want them to move up in credit quality and prepare for potentially higher rates and maybe even a slightly steepening yield curve.
We also think that it’s important that investors globalize their equity positions. This prior cycle has allowed many investors to think more domestically and less globally because domestic markets have outperformed international markets for a number of years in a row. We think that is changing right now, and it’s important investors acknowledge it.
Darrell: We would also just make sure that investors stick to your plan and be focused and disciplined about rebalancing. As equity prices move and bond yields move, it creates distortions from your intended strategic allocations that you want to have in your portfolio. So it’s an important time to really look at those and make sure that you have the strategic allocations that you want in today’s environment.
Laurie: Thanks for that, Darrell. Will you leave us with a parting thought?
Darrell: Sure Laurie. Our outlook is for continued strong global economic growth and equity fundamentals if you’re positive. A disciplined plan to allocate cash at regular intervals in the market pullback should help investors reallocate to those sectors and asset classes where there’s value. The Wells Fargo Investment Institute will be closely following the markets and providing regular updates for investors for you to take advantage of.
Laurie: That’s all the time we have for this episode. I’d like to remind our audience to visit our blog, Advantage Voice®, for Darrell’s February 2 article, “The State of the Markets.” But be sure to make returns visits as we’ll have more from him as we go forward. With that, Darrell, thank you for joining us.
Darrell: Thank you for having me on, Laurie.
Laurie: And thank you to our audience for listening in. Until next time, I’m Laurie King. Take care.
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