Playbook for the Next Market Pullback (Buy These Stocks Now)

If this market gets more volatile from here, where should investors be looking? Art Hogan is chief market strategist at Riley Wealth and joins us now. Art, great to have you back. Thanks so much for being here. Well, it's great to be back. And thanks so much for having me. Well, Art, we're glad you're kicking off the week with us. We're seeing right across the screen right now. If you wanted to build a portfolio that could survive a bigger downturn than this without sitting in cash out. What would it look like? Yeah, a couple things, and I think that's a great question we should be asking ourselves all the time, not as it just is everything about artificial intelligence and what that's driving in the technology world, or is there smart places to be diversified. And I think the answer to that is there's always smart places to be diversified. I think one of the things to think about is, yes, artificial intelligence is driving a lot of the earnings growth, but not all of the earnings growth in the S&P 500, which you're going to find out about over the course of the next couple of weeks. This will be the first quarter. The second quarter of this year will be the first quarter and five quarters that all 11 of the S&P 500 sectors are going to have earnings growth. So it's been a while since it's been all about technology and communication services. And that's basically with a mag seven live. So I think this is a great opportunity for investors to say what else. And that what else can be a lot of things. I think small caps have certainly been part of that, something other than tech. I think that looking at things like industrials and financials and health care, three sectors that are actually outperforming, this year, versus, how they were doing last year, significant, improvement both in earnings and a lot of excitement about, M&A activity. So I think it's wise to always keep yourself balanced and have some diversification. And the best way to do that is have a structure such that if you get overweight, let's say you started out with a 5% position and pick a company, Nvidia. And now that's a 12% position. And just know on a quarterly basis you want to pull some of that back and invest in some of the things like those healthcare stocks in the financials in the industrials. Okay. So let's break down your barbell approach a little bit more. So there is the tech and growth on the one side. And then what specifically on the other side. So industrials financials and health care are the three sectors we think have the biggest opportunity to outperform this year. And some of the drivers are pretty straightforward. Industrials obviously a big part of the build out of data centers comes from the industrials but also a rebuild of our infrastructure which is desperately needed. So industrials are really having a renaissance right now. And I think we'll continue. Financials are doing great for a couple of reasons, not the least of which is capital markets. Activity is very busy. We've seen some massive IPOs. There's likely more to come. We've seen actually eight times as many M&A transactions this past quarter than we did a year ago quarter. So M&A activity has picked up. But I also think that the financials are benefiting from the fact they've been ignored for too long. And I think that will continue to start picking up. And they're getting more and more attention. They were one of the best performing sectors in the S&P 500 last quarter. And I think they will continue to throughout this year. The third in one of my favorites is health care. There's three reasons here right. Health care is amazing. And so much is there are so many interesting and exciting new developing, drugs in the clinic right now in stage three that we're just starting to see the M&A activity that happens. So a small cap biotech company will work very diligently to research, find something promising, get it through the clinic. But very rarely do they have the ability to commercialize that. So you're seeing a lot of transactions. Eli Lilly has already had six, six transactions of this year alone of biotech companies. And I think that continues. And one of the things that's helping that process along is there's a bit of a lighter regulatory touch when it comes to approval of mergers. So that's why those three sectors are three of our favorites to balance off your holdings in technology and truly have that barbell approach of diversification. What's the best way to get exposure to financials, industrials health care. Are you stock picking specific banks. If so, which one are specific health care companies industrial companies. Yeah for sure. So I think there's a couple of different ways you can do it. It's all about the preference of the individual investor. So we have a focus list that actually has names that are in those spaces, for example. And that's one of our favorite of the industrial names, JP Morgan. And these are two of our favorites in the financial side. On the healthcare side, Eli Lilly has been one of our best performing names on the focus list for the last couple of years, but so is AbbVie. So you can be a stock picker or another way of approach. It is the basket approach where you say, okay, the S&P 500 is an index, but each component has their own index. So you can just have exposure to those three sectors in an ETF fashion and participate in that and the upside. So I think that's another easier way to play it as opposed to say, okay, I need to be a stockbroker here. Both ways work. Both are giving you diversification. But if you just want to balance out and have, have the technology sector on one side of your barbell approach, you just have the three sector ETFs for the other. Okay. Some might hear financials, industrials, health care. Although industrials actually the third best performing sector so far this year. But they might hear those sectors and think lower returns. So what would you say to someone who worries about missing out on potential gains by having exposure there. Well I think a I think that would you rather write here's one of those would you rather questions, would you rather be buying the financials at an all time high or actually when they're just improving and the fundamentals are improving. The same thing that holds true for healthcare and certainly industrials here. Point is had a very good run. Investors recognize the need for industrials throughout the last three and a half or four years that ChatGPT has rolled out. And data centers deserve to be built. But all of that having been said, I think that this being to balance out your portfolio risk, your allocations should be diversified, that diversification is going to help soften any blows. If technology has a major pullback, because you'd be in sectors that offset that. We've seen that happen in most of the down days we've had over the course of the last month. Where do you see a big tech selloff, whatever that driver happens to be in taking profits in semiconductors or software stocks are down three. The best performing sectors while it's been happening have been industrials financials and healthcare stocks. So I think that's another way to look at it. We do have big bank earnings season and regional bank earnings coming out this week. Would you hold off on adding any financials exposure until starting tomorrow when we start to hear from them or you have enough conviction that you do it today? Yeah, I you know what? It's very difficult. And I think that's a great question. So earnings season as a catalyst gets difficult. If in fact you're coming into the season with some of the big banks trading at or near all time highs for some very good reasons. So JP Morgan is a great example of that. It's trading close to its all time highs. It's almost a $900 billion company know. So therefore the reaction function to its earnings which will likely be very good for a great earnings. Great revenues, terrific guidance may have that counterintuitive impact in the marketplace because it's trading at an all time high. So I think it's best to always wait till after earnings season to make a decision. So to me I would like to see all the banks report, let the dust settled and come in in a week and a half or two weeks and say, all right, JP Morgan is almost exactly where it was when I didn't buy. It's time to buy it now. But I don't have to worry about, you know, that funny dance that companies can do on that sort of buy the rumor, sell the news, earnings season. So, you know, to your point, it's probably a good idea to take a week, see how things get digested after earnings and then and then, and then to the sticky toe in the water. Regional banks have had a really good year. I say start to the year, but first half of the year, I guess I should say, would you be interested in buying regional banks as well after earnings, or are you mostly talking big banks now? I think the regionals are going to be a terrific play this year because we have too many of them. Right. So and it's very expensive to run a bank both with compliance cost and technology cost. So to the extent that we're a developed country, we have more banks than any other developed country in the world. We are probably over banked. We're likely going to see a lot of M&A activity and roll up activity, and that's likely going to sit in the regional bank world. So to the extent that small, community banks and some of the small regional banks are likely going to be rolled into larger regional banks or the Super regionals, and even some of the money center banks are going to likely be looking to expand it to geographies where they're not already. So I think that that's a that that one of the reasons we like the regional so much is there's just going to be fewer of them, because I think there's going to be a great deal of M&A activity over the next 24 months. Okay. All right. So we will hit the one side of the barbell shifting to the other side. What's still worth owning on the more offensive or the more, you know, the tech heavy side of the barbell, especially on a day like today where I'm seeing SanDisk down 8%, arm down almost 8%, micron is is off about 4%. What would you, buy on the dips and add to that side of the barbell? Yes, that's a great question. I will tell you this. It's so difficult to look at these daily moves without the perspective of saying, well, on a year to day basis, all the stocks we just named are up, you know, from 50 to 125%. Right. So these this kind of volatility is going to be the the norm, not the exception for these types of names. Three of our favorites in this group in the technology group Apple sort of sits at the top of that. They're doing a lot of exciting things, not the least of which is they finally delivered to us what their artificial intelligence strategy is going to be. They're a fast follower. They're partnering with companies to make Apple intelligence even more useful. So I think that for all that handwringing that was done at the beginning of this eight I revolution about what's Apple's tactic going to be, they've delivered that. They also have a new and exciting rollout coming. They still sit on a lot of cash. They're very shareholder friendly, management team. And they're trading at or near an all time high. And I think they've got higher go. I think another undervalued name in this space is Microsoft. Microsoft is a software company that's been kind of thrown out with the rest of the software companies, because artificial intelligence is going to disrupt all software. We disagree with that thesis, especially when it comes to Microsoft, which is embedded in 95% of the S&P five potential, workflows and very difficult to displace them. So I think it's probably one of the cheapest of the names, I think the best name in the business right now as it pertains to the technology space, is in video. They're trading at a below market multiple. They're growing their earnings and gross margins close to 80%. It's just phenomenal company that continues to reinvent itself. It's used a lot of its free cash flow to expand out its touch. So it's it's the cheapest of the best. And has been a source of funds this year. I really think it's a buying opportunity there. Okay. So you're a believer in the big seven still, or at least three of the Meg seven? We've been hearing a lot of calls to kind of trim the profits on those or to get out altogether lately. In terms of what you would be trimming here, though, what is that? What would you be, you know, taking profits on right now as it relates to tech? Well, I would get a little nervous about some of the new entrants, into the marketplace. We've seen that with, the Sky next deal that came out and the first time Americans had access to it through the ADR. And I've seen it and it came out that the stock had been up about 160% over the last 12 months. So you're buying at the peak. And, you know, there's been a lot of long term shareholders in Korea that can now sell into that path. Those are tricky things to try to articulate and play. So I'd be careful around that. Also understand that the the standard that needs to be driving a lot of the large language model developers had come from both equity and debt. And the debt markets with the the hyperscale debt market is starting to show some cracks. And by that, I mean it's not going to be as easy to float another $300 billion in debt for the rest of this year like they did in the first half of this year. But the spending needs are going to continue. So I would just be careful on some of the that because the large hyperscalers developers, the ones that are public now, are the ones are soon to become public because a lot of what you're buying into really is a belief in the future of return on invested capital. I'd rather be the guy that's selling the picks and shovels to these guys that are spending all that money. Give us some names. Art of the hyperscalers. Well, it's hard to. Know which ones you'd be avoiding. Yeah, I would avoid the latest of the space, IPOs is is spectacular. If you believe that the $18 billion that they made last year is going to turn to $380 billion by 2030, and I just don't know that investors can actually have a window into that being a possibility. So the multiples on that sort of sit in a place where you just have to believe in something happening 5 or 6 years down the road that, you know, could go either way. Right. So there's a name, I would just say it's just not for the faint of heart or for widows and orphans. It's just a it's a very speculative name that trades at a very high valuation and that a pull for forward a lot of that valuation into its current, pricing. And I think that that's one of the things that I'd be the most cautious of. And yes, they have a strategy and they're going to obviously put people on Mars. But you have to believe that's going to happen and they're going to be able to do it effectively by 2030. If you're playing, if you're paying today's price. So that's one of the ones. I just think it's it's easy to describe why you want to be careful there away from that. If you look at the the race to be the best of the large language models, I think it's going to be a horse race. And by that I mean, I don't think there's going to be 7 or 8 winners. There's going to be a win place in show. So as you look at the lead charts of who's got the best product out there right now, everyone believes it's anthropic it. It's much more of a business, the business type, model. But the that that leaves about five other models in its path that likely don't exist at the end of this race. So, you know, I just be careful with the understanding of all of these large language models aren't going to win this race. And picking the winner right now is good. It's definitely difficult. Okay. All right. If you could make just one portfolio change for the second half of the year, what would it be? That's a great question. And I think that the portfolio change that I would love to make right now is to buy a broken fallen angel stock. I don't know which I would rather, but it would sound something like Nike or Lululemon, because I think that the the damage has been done to those franchises is so massive that the opportunities that it's very high. Okay interesting. And then just in terms of risk, because we are looking at a lower market today as the U.S., Iran, you know, situation escalates, what is the biggest risk to the market right now and to your 7800 price target? I think you nailed it right in the in the question. It's the longer the war with Iran goes on, the longer that energy prices remain high, the more upward pressure that puts on inflation, the more upward pressure that puts on rates, the more that becomes a headwind to this market. I think we spent the first month of this war assuming that we'd find an off ramp sooner rather than later, and energy prices had come down almost to the prewar levels last week until this fire back up again. If we're still talking about this at the Labor Day, and energy prices are trading 75 to $80 and WTI gasoline is close to $5, that's going to slow down economic growth, and earnings estimates are going to have to come in. And a consumer driven economy that, that that, headwind to consumer discretionary spending is going to be a problem. So it's about duration. And that's going to force the Fed's hand with the upward pressure of inflation. So the longer this last without finding an off ramp, the more pressure that's going to put on GDP growth and earnings and become a larger headwind. So you know we've gotten through July 4th of we're just you and I are talking about this on Labor Day. The market is going to be lower okay. And I guess how much lower if oil remains at its at 74 right now. So if it's between 75 and 80 and we're still seeing this play out come Labor Day, what do we do. Yeah that's the persistency. So it's wild that the current month is really at $7,475. The forward month is trading lower. So if we start to get out of backwardation, just meaning that the forward month is higher than the current month, that just means people think this is going to last that much longer, and that impacts real cost, whether it's diesel fuel or jet fuel or gasoline prices. So right now, the market still believes this is going to be lower. In the fourth quarter of this year, if that flips itself around and then speculators are starting to say no, it's going to be this price or higher all the way into next year. That affects business decisions that are made in consumer decisions that are made in the market, that the earnings growth rate will likely slow from what we think in the second quarter should be, you know, close to 20% to a third quarter where that could be half of that. So that's that's the risk there. And then, you know, you can sort of do the math on what that means for equities. But how does that barbell shift then the the kind of safer, more boring side, if you will, versus the. Taxing side to. Stay invested into all of those areas or do you just hide out in cash. Yeah. So here's three things you still need when when the you know, when the economy is slowing, you still need health care. Right. And that's not something you, you know, you pull back on. Yes. You know you still need financial services. And that's not something that you necessarily pull back on even if you're paying 5 or $6 for gasoline. So you have to think about the things that you need versus the things that you want. If things are going to soften up and and all three of those things are things that we definitely need. So I did that. I would, you know, sort of make the case for the why there defensive are basically there things we need, not necessarily things that we really want okay. All right. I think this is a great time to pivot to our rapid fire game of this or that. It's going to be the Week Ahead edition because we didn't hit on some of the big things to look forward to this week. Are you played before? Quick questions, quick answers. Are you ready? I am ready. It's my favorite game on Wall Street. Woohoo I love it. All right here we go. Matters more for markets, CPI or bank earnings. Such a great question to the CPI. I wish it could be bankers. They're going to be fine. CPI is the only thing we care about because we care about what the fed is going to do next. If we get a CPI pullback, buy the dip immediately or wait for clarity. Wait for clarity. The KPIs bounced around a little bit where we're likely to see in line, but if you see something that actually is significantly lower, you want to see that for two months and not just one. Worries you. More sticky inflation or a slowing consumer sticky inflation. You know, I think betting against the U.S. consumer has been a bad bet for the last hundred years. I think it's the inflation that can make that consumer a little more cautious. But I think right now it's inflation, not the consumer. Rate cut or no rate cut this year. No rate cut this year. I think the only move the fed will make is just to keep rates where they are and likely cut in the first half of next year. More upside in the second half. Tech growth or a small cut value. Oh, such a great question. Small cap is outpacing tech growth. And the S&P 500 right now. If in fact interest rates are going to pop a little bit, I think tech is going to come back and small caps have to slow down. Industrials or financials. Super question advanced. Was that more upside. Financials have much more upside. Industrials have been a good one and two year play. They will continue to be a good play. But financials have much more upside. Trimmed tech or let it run. I think he let it run especially in those names that have actually been for sale since last October. That's almost all of the magic seven and all all of software. I think technology's got a nice recovery bounce coming in, especially if memory quiets down a bit. So if it's not right now, it's all about chips. I think if that comes down, that rotation goes into everything else that hasn't run. And I think there's plenty of that in technology. Memory boom, overhyped or underrated. It's it's it is what it is because of the fact that there's a supply demand imbalance and we can't fix that very rapidly. So some of the equity valuations overhyped. But that supply and demand for memory right now is real and will continue to be real, because it's a hard time to build a fab and produce more. One tech stock you'd buy here. One tech stack I would buy right now today, Apple Computer. I think it's the best of the bunch, and it's got a lot of, positive news in front of it, especially the roll out of its latest phone. One you avoid in technology. Meta. I have no idea what they're where they're going. They had a nice comp. I'm not sure what their business plan is. I get it seems like they hop from business plan to business plan. I know they're one of the big players, but of the bunch, I think that's the one I'm that I'm the least curious about. Better dip to buy SpaceX or SK Hynix. Oh, SK Hynix, they actually have revenues and earnings and, and produce things that we all need space. You have to believe they're going to be doing something great in the 2030s. Netflix value or trap? I think that Netflix is a value. I think nobody wants to be in the space of content and content production. And but you and I are going to be continuing to consume content, and Netflix is going to be one of the ways we do it. I think they're the they're clearly the leader in all of that. Ahead of earnings JP Morgan or Goldman Sachs. Oh great question. JP Morgan I think is a better run company. But it's more expensive than Goldman Sachs. And I think they both had great quarter. So the possibility that Goldman Sachs may have a better reaction to their actual earnings. United reports Wednesday buy it or sideline it. The United I'd say on the sideline and I see that. I think there's a lot more we need to learn about how the future looks for them. So I don't think you need to get in front of one. United or Delta. Delta is the best run in the business right now. And I think with some of the consolidation and some of the discounters going out of business, they're just going to pick up more. So I think Delta's probably the best in the business. I you know, I would lean into it. S&P 500 price target by year end. We currently have a 7800 S&P 500 target for year end. The bias of that is likely to the upside, especially after earnings reporting season when companies have a chance to change their guidance. And I think if guidance goes higher that the full year earnings the S&P 500 was using, the same multiple, we may even get to call it eight, 8000. But, I'll talk to in three weeks about that. In a word, what gets us there? Earnings. And in a word, what derails it. Inflation doing damage to those earnings. Inflation at what level? Okay. Inflation at a higher level than we are but for a longer period of time. So if our CPI is going to go from a three able to a four handle and we're going to still be there in the first quarter of next year, that's what the headwind to earnings would look like. Okay, we have so many things to mark our calendar with Labor Day first quarter of next year. Our Hogan chief market strategist be rally. Well thank you so much. Always a pleasure. Always a pleasure. Thank you. If you enjoyed this street talk check out our full interview with Andrew Graham. He gives his take on AI CapEx spending and offers his top picks.