Buy energy, small caps on dip -Hogan

With the Russell 2000 down nearly 6% from its peak, National Securities Chief Market Strategist Art Hogan tells Reuters' Fred Katayama why investors should consider buying small cap stocks as well as energy ETFs like XLE.

Video Transcript

- Tech stocks driving the S&P 500 to another record high Thursday with the NASDAQ in the lead. But volumes have been receding of late. Let's get the implications of that from Art Hogan, chief market strategist at National Securities. Welcome back and good afternoon art.

So we've got trading volumes even pulling back lately the S&P 500 not just one record high after another. So what are investors what is this pattern telling us. Or is there a lack of conviction, or the market's topping up. What's your read.

- Yeah, well there's three things I'd say on that front. First and foremost, I would say you never want to short a dull market. And that's something that's been drilled into my head over the last 30 years.

The second thing is some of the pullback in volumes has to do with the fact that we're seeing fewer spec issuance. Issued almost 300 specs at in the first quarter of this year. That is really slowed down precipitously. So that volume has been removed.

I would also argue that some of that Reddit Robin Hood meem stock volume has quieted down quite a bit. So some of that average daily volume we saw in the first quarter, which is close to $14 billion shares a day has pulled back. I think that accounts for a lot of what we're seeing. So now in the average of between 9 and 9 and a half billion shares a day this week.

The second thing that focus on is equally important is at or near all time highs. The week before we start earnings. You tend to find investors taking a wait and see approach. And I think this is the wait and see week.

- And do investors have anything to worry about. Do you think the earnings that we get during earnings season will back up the current valuations.

- I think in general earnings are going to be great and better than expected. But where I would be concerned, a little bit concerned on two fronts.

First, I'd be concerned that if you're a multinational. This has really been a two speed normalization of economic activity. So domestically, we're reopening faster than a lot of European countries.

So multinational may find themselves having to talk about how some of their international business is a little bit slower than their domestic business. And if that's not factored in to estimates out there, then that might catch you by surprise. We saw a little bit about TJ Max and John Williams spoke to some international slowness and their business.

So I understand every day we hear about Ontario, and France, and different parts of the globe that are putting new restrictions on. So that's one piece of a concern about.

The second piece of a concern about is while we're having earnings season start, starting tomorrow and into Tuesday, we're going to see some inflation data. This inflation is going to start to run hot. The March data for TPE likely on a year over year basis is likely to be closer to 3% than it is to 2 and a half.

CPI very similar. So we're going to start to see creeping inflation. Not that matters to the Fed, but it may matter to investors as we've never lived in a world where the framework of the Fed is asymmetric on their target for inflation.

So that might cause some disruption in investors psyche. Hey, inflation's running hot. The Fed's likely to pull in the reins on monetary policy. They've been very clear that they're not going to, but no one has been in a world where the Fed has been this dovish and this casual about inflation waiting for full employment.

- What do you think then, given what your concerns about inflation about 10 year Treasury. It's sort of stabilizing. It's sort of pulled back a bit to the one 1 6 5 level 1 6 4.

- Yeah. So that parabolic move we saw about six weeks ago when we crossed over 1 and a half. And basically, went in a straight line of 1 7 7, which is the high tech so far has really quieted down. It also coincided with the flip of that calendar.

You and I have talked about this a little bit in the past. Japan has become a net buyer of US treasuries. There were a net seller the first quarter. So I think that has helped calm down.

It's also a reflection of our expectations for economic activity. So it's all right if the yield on the 10 year goes higher, if it's going higher for the right reasons which we think it is. It's just not all right if it happens 20 basis points a week. And it's the pace at which we get there.

So I think, we can start working our way higher and the year somewhere between two and 2 and a half on the yield on the 10 year. The markets will be fine with that. But if we get there in a month, the markets will get disorderly again.

- And lastly, are the Russell 2000 saw a lot of activity earlier this year. Sort of topped out at 2360 on the 15th. But has pulled back about 5%. Since then, right now it's hovering right around the 50 day moving average.

- The Russell 2000 had explosive growth that outpaced the S&P 500 last year and this year in the first quarter. So at some point in time, we expected that to consolidate a bit.

The Russell 2000 very domestically focused, but we understand about 30% of the Russell 2000 doesn't have earnings necessarily. So the multiples got stretched, the RSI or the relative strength index, which was pointing to an index that was overbought.

And unfortunately, a lot of those really active mean stocks that the Robin Hood Reddit gang like are in the Russell 2000. When they stopped playing those names, part of that came down. The top five names in the Russell 2000 in the first quarter were all named stocks.

So I think part of that. But I think the Russell 2000 being domestically focused, very cyclical having a lot of regional banks and a lot of energy exposure is going to outperform the S&P 500 again this year.

- So time to buy on this pullback.

- I would certainly buy that. And the other thing to buy right now is energy. Energy has had a significant pullback. I think that the commodity is reflecting a better future for energy than the equities are.

So if you look at the XLE or the energy ETF, that has pulled back significantly. And I think this is the level where that might become interesting.

- All right. Thank you for your thoughts.

- Thank you.

- Our Thanks as always to Art Hogan of National Securities. I'm Fred Katayama in New York. This is Reuters.