Strategist Sees Recession Ending By Year-End

Stuart T. Freeman, is senior vice president and chief equity strategist for Wells Fargo Advisors and held the same position with A.G. Edwards & Sons Inc.

The June jobless number — a loss of 467,000 jobs — spooked the stock market with fears the recession won’t end by year-end. Is that an exaggeration?

S.F.: I think the action on that news was an exaggeration. The initial claims number for the previous week was 614,000, and the revised number from the week before was 630,000, so that number is lower, Also, the continuing claims numbers that include those that were initial and are continuing were a little bit lower than the prior numbers.

It’s also the case that those initial claims numbers would have to be 50 percent higher to compare with what we were seeing in the early 1980s when we were in an extended period of very rough employment conditions. If you compare the numbers with the size of the economy now they’d have to be around 900,000 initial claims to be equal to that.

When do you see an end to job losses?

S.F.: Unemployment is a traditional lagging indicator, so you could have the unemployment numbers rising even through the first year of a recovery. There’s a good chance job losses could continue through the end of this year and at least into the middle of next year, but at a slowing pace.

So do you see the recession ending by year-end?

S.F.: We still do. If you look at the sub-indicators supporting the leading indicators, you see more and more of those making the case for recovery as opposed to recession. The way that those look right now is very similar to the way they looked and the percentage changes we were seeing in the beginning of the last recovery in the early 2000s. We think that even the second quarter was positive in terms of Gross Domestic Product, if you don’t take inventory draw-downs into the equation. It’s still very possible that even the third quarter may be flat to modestly positive. The fourth quarter could be something like 2 percent growth.

The recent stock market rally was led by the financials, the most pummeled sector in the long market plunge. Isn’t that a sign of a bear market rally rather than a new bull market?

S.F.: Financials and interest-rate-sensitive stocks tend to move early in a slowdown as the Federal Reserve brings interest rates down, and they tend to outperform as a new bull market starts. Then as the economy moves into the later stages and we have more breadth to earnings and more inflation concerns mid-cycle to late in the cycle, financials tend not to be outperformers. What we see with financials isn’t too much of a surprise, with investors saying maybe the entire financial system isn’t taking us into depression. That’s why we saw the financials, smaller stocks, and high-yield higher-risk bonds performing very well over the last three, four, and five months.

Is a prolonged stock market correction in the cards?

S.F.: We think we’re going to consolidate here for a couple of months with pullbacks in some of the stocks that have moved up — consumer-cyclicals, energy stocks, and the financials.

But we don’t think we’re looking at a market that has already discounted a recovery, and we don’t see it going back to where we were when panic was pushing the S&P 500 onto the 666 level, around its bottom in March.

We could have a 10 percent rolling correction for a while, but we expect we’ll be higher as we get to the end of the year or early next year.

What kinds of stocks do you like and dislike?

S.F.: We’ve been constructive on the consumer cyclical stocks for a while. The consumer cyclical and consumer discretionary sector underperformed between late 2004 and late 2007 when the market really started going down. From July 2008 we went to even-weight on consumer discretionaries.

We’re overweight on the industrials. They’ve been hit hard. The manufacturing companies, the industrials tend to get their day in the sun later in a recovery, and they look very attractive. We’re looking out three years, and there are some opportunities here.

The defensive stocks where everyone wants to hide will underperform as you move into recovery and frequently for multi-years, so we’re underweight health care. Also, investors continue to worry about margins as a result of healthcare reform.

We’re still even-weight consumer staples, but once we’re through this corrective phase, we would be very cautious with them. They’re likely to be underperformers after this correction.

We’re also underweight the utilities, which have been tremendous underperformers in the rally since early March.

Once we’re out of this consolidation phase and you start to see positive earnings on the books from more cyclically-sensitive companies, we expect the interest in utilities will continue to wane, and they’ll underperform for the next 12 months.

We’re overweight telecom. We like the total return potential, with more and more people using data and more and more devices for data declining in price, and we like the valuations of the stocks.