Main Street is the clear beneficiary of the economic recovery: Co-Chief Investment Officer

Craig Fehr, Edward Jones Principal & Investment Strategist and Francis Gannon, Royce Investment Partners Co-Chief Investment Officer join the Yahoo Finance Live panel to discuss the latest market action.

Video Transcript

AKIKO FUJITA: Well, let's turn our attention back to the markets with our next two guests. We've got Craig Fehr, Edward Jones Investment strategist. We've also got Francis Gannon, co-chief investment officer at Royce Investment Partners. Let's start with you, Craig, because it feels like all the variables are lining up right now to sort of supercharge the economy. Jess just talked about the infrastructure package that would come on top of that $1.9 trillion stimulus plan that's already been passed. You've said that the road to markets pushing higher is a bit windier, though. What do you see right now that raises maybe some red flags or potential bumps in the road?

CRAIG FEHR: Yeah, Akiko, I think you're right in that the stars are lining up well for the fundamental backdrop for this market to continue to be quite positive this year. We've got monetary policy that's largely still quite favorable, although we might see some adjustments there. Fiscal policy is clearly a heavy wind at the back. And then we've got the labor market that continues to improve. That's exactly what combination or cocktail you'd want to see for a growing economy in a positive market.

I just think we're going to see a bit of role reversal this year. If you think back over the past 12 months, the economy and the stock market have been in very different places with the stock market returning to new highs as early as last August and now pushing higher while the economy was slugging along. And I think this year, we're going to get a lot of momentum in the economy. And it's going to be the market that's going to proceed more than a two step forward, one step back type of fashion.

So as you noted, we seem to be unveiling fiscal stimulus plans to the tune of 10% of GDP quite regularly these days. That part has been necessary, given some of the damage that's occurred to the economy. I think the complexion is just going to change a little bit with an infrastructure bill relative to, up until this point, what has been direct payments to taxpayers and direct relief to businesses.

ZACK GUZMAN: Yeah, and Francis, you just heard from Jess there kind of Republicans talking about this infrastructure plan, flexing their concerns around moving the corporate tax rate higher. When you look at where we're at in this recovery, how much of an impact might you think that would have on businesses who are trying to kind of get back to normal here and where we sit in this recovery?

FRANCIS GANNON: Sure, I think we're still in the early stages of the recovery. I think as Craig alluded to, this is going to be a year of Wall Street versus Main Street. Main Street this year is going to be the clear beneficiary of this economic recovery. And we're moving, really, from recovery into expansion. And that's going to be the key, key to this story in terms of the market. And particularly, small caps is going to be earnings and earnings growth.

If you raise corporate taxes, small cap companies tend to pay their taxes, right? They don't have all the different divisions and earnings from outside the US, et cetera, where they can find losses or harvest losses. Most small cap companies tend to pay their taxes. So it will have an effect on corporate earnings within the small cap space. I would say, though, that I think that the earnings story for small caps this year and into next is going to be quite powerful, especially given the fact that we're talking about GDP numbers being north of 5% over the next several quarters.

AKIKO FUJITA: So Francis, let's talk about strategy then. What do you like in the small cap space?

FRANCIS GANNON: I think within the small cap space, we've just had a powerful year. You know, the one-year number for the Russell 2000 as of this morning was around 91% return. Small caps bottomed on March 18 of last year. And we saw about over 130% return for the index. So I think what you're happening to see now as we rotate into year two of this bull market of recovery within the small cap space is earnings are going to be increasingly more important.

I think the type of businesses you own are going to be increasingly more important. And this is an environment where we're going to see the small cap cyclicals continue to do quite well. And I think that's the most important part of the story here, is that focus on the more cyclical economically sensitive areas of the overall market. That's where you want to be positioned right now.

ZACK GUZMAN: Yeah, and I mean, when we look at that, too, Craig, on the other side, kind of looking more broader market, it does seem like some of those companies that had been favorites before in this stay-at-home trade have been beaten down. You think about, though, a Chewy, which you're going to be talking about later, that showed some renewed strength and maybe expectations were just low there. I mean, what about this rotation might be going too far when we think about some of those big growth drivers before and how the rest of the year might shake out in terms of winners and losers?

CRAIG FEHR: The way I would interpret that is I think we're going to see the pendulum as it has for the last several months. I think we'll see the pendulum swing a little bit too far in one direction or another in terms of the momentum that we're seeing in the market. I like Francis's word. I think he's spot on. Rotation is exactly what I think we're going to see play out. Now, it's interesting. If you think back historically, the risk on, risk off rotation would be a surge in equity prices or stock prices. And then when the risk off attitude comes in periodically, that's a shift into bonds.

What we're seeing more recently is that that risk on, risk off is cyclicals and value is a risk on day, and then we're seeing a movement back into growth in those kind of risk off or more defensive days. And I think we could see more of that. But just as you noted-- and I know you brought up Chewy, which we're throwing plenty of money at as well, given our dog situation in the house-- I think it's that earnings story that Francis had touched on, which is that I think the next leg of this bull market, we've seen the big deep breath rally off the lows of last March.

Now the next leg of this is going to be powered by the most compelling earnings stories. And I think that's both at an asset class level. I would agree small caps look quite compelling there. And I think from a sector level, I think you're going to see a continuous rotation. Tech continues to have a compelling secular growth story, but you look at financials, which benefit from a steepening yield curve. You look at industrials that, speaking of today's news, could benefit greatly from increased infrastructure spending. I think we're going to continue to see a rotation back and forth. And the market's really going to pay attention to the most compelling earnings stories.

AKIKO FUJITA: OK, great to have both of you on today. Craig Fehr, principal Edward Jones Investment strategist, as well as Francis Gannon, co-chief investment officer at Royce Investment Partners.