How to play the market rotation: strategist

Amid the on-again off-again sector rotation hitting stocks, National Securities' Art Hogan tells Reuters' Fred Katayama investors should employ a barbell approach that bets on growth and cyclical stocks. He also identifies his favorite cyclical sectors.

Video Transcript

FRED KATAYAMA: Thursday, start of the day is a tale of two markets with a rotation back towards techs and away from cyclicals. But now all sectors are in the red, and big indexes are all in the red as well. Well, to figure this out, let's ask Art Hogan of National Securities. Art, welcome back.

So a choppy week of the rotation Monday, Tuesday toward cyclicals, away from tech. And then we saw a sharp reversal of that Wednesday and earlier this morning. But now everything's in the red. So we've seen that rotation go in and out during the summer, is this the real deal or not?

ART HOGAN: Yeah, well, I think we have to step back and think about what's really driving us here. And you're-- that's very correct. We've had fits and starts with a rotation out of growth and into cyclicals. We saw that in June for a bit. We certainly saw that in the August and September timeframe.

What's happening now is it's predicated on an assumption that we're going to have better economic growth, largely due to the fact that we're starting to get readouts on vaccines. So we're seeing to the other side of this pandemic at some point in time next year, and the markets are forward pricing mechanism. So what does that mean?

It's take all those stocks that have worked well agnostic of the pandemic and rotate into those things that haven't done well because economic activity this year has been not great. I think what's going on this week is that back and forth of, OK, have we overdone that trade in two days, and, you know, do we need to sort of shoot that back like we did yesterday?

I think this is a very long trend. And in a real sense, growth is up before value for the last 10 years, right? And 80 years before that, value outperformed growth. So, you know, the legs that this particular rotation has I would argue are very long and well into '21. But I think the best way to approach it is to have a balance of both.

So for 2020, we've had, in our 60-40 portfolio, our 40%-- our 60% has been balanced between both, barbell approach of having growth on one side, the mega cap technologies and health care stocks. On the other side, economically sensitive cyclicals. And then you rebalance that every two months.

So basically, when you're getting out of position, when you have too much value in your technology stocks, you pare that back down to your original level, and you buy the undervalued cyclicals. My guess is the next rotation that we do out of that next rebalance, we're going to be selling cyclicals and buying some of those technology names. It would be the first time this year that we've had to do that.

But I think this is-- that's the best way to approach that. Then you have a diversified portfolio heading into next year, and it works for you both times.

FRED KATAYAMA: And with that barbell approach, Art, what percent would you put in, say, tech growth versus cyclicals?

ART HOGAN: Well, I did-- it's-- right now, we're at 50-50. And I think that's fine. And when we look at growth, it's not just technology, there's growth to be found in a lot of sectors. But technology just happens to be our heaviest weighting, health care is also in there, it's our second heaviest weighting. In cyclical, the three sectors that we really are favoring our financials, industrials, and materials.

We'd love to have energy in there because they really are trading at a deep value. But I think there's a whole cohort of investors that just don't want to invest in energy. So while the commodity might do better next year, equities might not correlate as tightly to that commodity increase. We're just afraid of that sector a little bit. It's almost like the new tobacco, where investors are just shy of that.

FRED KATAYAMA: What did you see in the trading, say, Monday, Tuesday that makes you think that this time we're in for a long-term trend towards cyclicals after that long trend toward tech?

ART HOGAN: Well, I think what we saw was the reason, the driver, the catalyst. And all of that is predicated on a better economic activity. So that's why it makes sense. Before, I think it was based on valuations. Technology has gotten overdone, it's overbought, and cyclicals are oversold. Right now, I think it's based on clear evidence that on the other side of this pandemic with a vaccine, economic activity picks up.

FRED KATAYAMA: All right, thanks, Art. Our thanks to Art Hogan of National Securities. I'm Fred Katayama in New York. This is Reuters.