Why these mid-caps are the place to invest: Strategist

The Dow Jones (^DJI) closed higher for the fifth week in a row, this time above 40,000. Hennessy Funds CIO and Portfolio Manager Ryan Kelley and RBC Capital Markets US Economist Michael Reid join Market Domination Overtime to discuss what it could signal for the overall state of the economy.

Kelley believes the record high is fueled by anticipation of the Federal Reserve lowering interest rates, as well as easing concerns of a recession.

Reid says that the economy is experiencing several tailwinds as retirement portfolios increase in value and Baby Boomers start to use those assets. Higher interest rates are also boosting the overall wealth of higher-income individuals and HVAC and building companies.

For more expert insight and the latest market action, click here to watch this full episode of Market Domination Overtime.

This post was written by Melanie Riehl

Video transcript

The Dow closing higher for the fifth week in a row and today, closing above 40,000 for the first time ever.

Here with more on the path ahead for investors is Ryan Kelly Hennessy, funds CIO and portfolio manager, along with R BC Capital Market.

It's US economist Michael Reed.

Welcome, guys.

Both of the show.

Uh, so, Ryan, maybe we'll start there.

Dow closing record high above 40,000.

A big round number.

It's gonna get attention and headlines.

What's been driving this, Ryan?

This market rally and do you see that momentum continuing?

You know, thanks for having me on.

I think that, uh, obviously there's a lot of exuberance in the market right now.

Um, 40,000.

Huge number.

We've never seen it before as far as a closing level.

Uh, this is, um, for a few different reasons.

Obviously, uh, the expected next move for the Fed, even though it might be quite a ways out, is to lower rates.

Also, we have, um, the idea and the worry of a slowdown in the economy or a recession that's all kind of behind us as well.

So you put those together, and I think that we're setting ourselves up for still a pretty good year.

Uh, from here, forward, Michael, um, you're here with the sunset.

Is the idea of a recession put to bed?

I mean, we talked to Bob Dole of Crossmark at the top of the show.

He's still worried about one before the end of the year.

What do you think?

Sure.

Thanks for having me.

Uh, we don't see a recession ahead for the US economy.

Um, we do see a lot of tail winds, especially in the consumer space.

Uh, one thing we've talked a lot about is, uh, the rise in retirement assets, Uh, both, uh, portfolios, um, that are increasing in value, and and the sheer size of the baby boomer generation that's retiring and starting to draw down those assets.

Um, that's showing up in the economy in terms of consumer spending.

So that's a really strong tail wind and Ryan back to you.

So you say you're looking for a pretty good year.

Uh, for the rest of 2024.

Here.

Ryan, how do you wanna put money to work in this environment?

What?

What are you screening for?

Well, I think we stick to what we always do here.

Um, you know, one of the spaces that we really like, Um, which has, um, lagged the rest of the market.

It's a little bit better valuation metrics than the broader market right now is the mid cap space.

Um, we have always liked midcaps, uh, here at Hennessy.

Um, but in this particular time, I think that, um, first of all these this market move we've seen really since last October is more broad based.

So that's really good to see.

It's not just large cap tech or working from home stocks that we had three years ago.

Um, it's much more broad based and in fact, this year already, uh, while the overall market, the S and PS about 12%.

A lot of the sectors are about that same amount as well.

There's not really one major sector pushing the rest, So the mid caps we like them because they're big enough to matter.

They've gotten to a certain size already.

Uh, they can still grow a lot organically because they, uh they can still take market share or maybe move into other industries.

Uh, and yet are still important enough that a larger cap company could acquire them.

So you put those together along with a little bit better valuation right now than our overall market.

And I think mid caps are a pretty good place to look going forward, Michael.

Kind of switching back to the economy here and talking about the different sort of parts of the economy.

I guess if you're talking about corporate size right, although you probably think more about about consumer income tranches right and and how they're doing kind of walk us through your thinking on where the consumer is in those different tranches right now.

Sure, and I think where some of the recession talk is coming in is when you look at the the lower income spectrum, Um, we are seeing things like credit card delinquencies.

Rising auto loan delinquencies are on the rise, and those folks that do rely more on credit for their spending, um, are feeling that pinch of higher rates.

Um, on the other hand, when we think about those higher income earners and especially retirees, um, a lot of their income is being boosted by higher interest rates.

So, um, interest income is something that is a bit of a tailwind, um, at the higher end of the spectrum.

But in either case, I think what's important for the economy.

Um, getting back to this concept of retirees that's gonna put downward pressure on the unemployment rate.

So even those folks who are feeling that pinch of inflation can be pretty confident that they're gonna have a job.

You know, over the course of the next year, we don't really see the unemployment rate rising meaningfully above 4% through the end of this year.

You know, since you have talked a little bit about the retirees, I want to bring up a sort of a provocative idea that Rick Rieder of BlackRock talked about in an interview with Bloomberg recently, where he said the answer is actually to bring interest rates down in order to bring inflation down.

And he reasoned that because so many people, not just retirees, but lots of people are putting more money in fixed income because they're getting a high yield on that, then they have that money to spend.

And he argued, if you cut the rate, then that money will come out of fixed income, people will be as much on it does that.

If I'm If I'm explaining it correctly, does that make sense to you?

Yeah.

You know, I think I think you have the right idea there.

Um, and that, in a sense, does make, uh, some sense in terms of where the the pressure is, uh, for service of spending.

Um, where we look at the strength, we see it in categories where, uh, the 55 plus cohort tends to be overrepresented, so things like dining out.

Um, you know, uh, hotels travels, Uh, and and medical care, uh, is is another big one for that particular, uh, segment.

So, um, if you take away some of the spending power from kind of the higher end of the income spectrum, that would take some of the strength we do see in the the consumer.

Ryan, back to you.

So So you sound, you know, generally constructive on on the market, Ryan and told us kind of how you're screening for names.

Can you give us some, uh, a couple of names?

Ryan, that would be, you know, just kind of representative holdings in the fund right now.

Absolutely.

Um, so in in the Hennessy Cornerstone MidCap 30 fund.

We look for companies that are, um that that, uh, are trading at a good valuation, uh, for companies that have some momentum behind them and companies that have earnings growth.

So the interesting part about this portfolio is that you'll find names that probably aren't talked about a lot and probably aren't in a whole lot of other portfolios, either.

We own Gap, Abercrombie and Fitch.

And guess, uh, we we purchased all those last October.

Um, Abercrombie, for instance, is up 100 and 50% since that time.

Uh, these are companies that were out of favour.

Uh, they were trading at fine valuations when we look at them.

Uh, but they had turned a corner and then they because of various reasons number one, the consumer stayed strong.

Uh, the holiday season was excellent.

Uh, they've done very well.

We've also owned or we own right now, a couple of other names that, um, they are HV AC system companies.

They they provide heating and cooling, uh, Modine manufacturing as well as comfort systems.

Both those companies again fit our criteria.

We added them to the fund, and they done pretty Well, so you know, this fund is an interesting fund in that we're not buying the same kind of names that you might talk about or see a lot, but they're at good value as far as we see them.

And, um, so far this year, it's worked out pretty well, And, uh, I'm curious, you know, because we talk about a lot of these names.

Maybe that are being affected by higher for longer interest rates.

Is that a Is that a risk when you're talking about especially something like H Vac, which maybe people are financing in some cases, right, I Is that a risk?

It it it can be a risk for for in particular for these H vac companies.

Interestingly, I think they're actually a tertiary type play on the A. I, uh, on what's going on in a I we have the A i companies.

We have the, uh um uh, you know, the the hardware and the networking companies that are also benefiting from the A I boom.

And then you have interestingly building companies and H vac systems that are benefiting as well.

So there's some that going on.

Um, but as far as overall interest rate risk in the portfolio.

We don't really have as much, um, of exposure to that.

We don't really have many financials.

Um, you know, utilities that are more cyclical, we don't really own those as much, so they don't really kind of make it into the portfolio in general.

So this is more of an idiosyncratic type portfolio, and you're not gonna see a lot of those macro trends affecting the individual companies quite as much.

And as we're talking about interest rates, Michael, I want to close it out with you and ask what you think is going to happen this year with rates.

Sure.

So we are looking for the Fed to cut this year.

Importantly, we don't see them really being able to do so until December.

Partly that's because of the election, but also thinking about what happened with the last EP I report.

While April was a step in the right direction, it doesn't provide that confidence that we're on a sustainable path.

Lower.

Um, so we really need to see that trend continue and and see prints that are closer to 2/10 or even 1/10 on a month over month basis.

Um, that would allow the Fed then to start their cutting process.

All right, Michael Ryan.

Thank you, guys.

Both for joining the show today.

Appreciate it.