Stocks recently had a tough day, and with Japanese equities (at the time of writing the Nikkei 225 is down by 6.6%) crashing on June 12, some are speculating that this is the end of the market rally for 2013.
Macro picture
There is a high possibility that both equity volatility and bond market volatility are forcing investors into cold hard cash. On one hand, we have policy easing that will end once unemployment reaches 6.5%. If Federal fund rates are going to go up, than long-term interest rates, along with Treasury bond yields, will go up. If yields are up, coupon values go down, and a wave of depreciation hits bond investors, which can be clearly illustrated by the chart below.
Source: Ycharts
Both the Ishares Barclays TIPS Bond Fund ETF and SPDRs S&P Depository Receipts fund have declined in value over the past five days. This type of behavior is not typical. The reason for this weird movement is that bond investors are fleeing the bond market due to the eventual rise in bond yields. Equity investors are pulling out of coupon-like names like Chevron Corporation (NYSE:CVX), E I Du Pont De Nemours And Co (NYSE:DD), and Johnson & Johnson (NYSE:JNJ).
At the same time, high-volatility, high-beta names like Tesla Motors Inc (NASDAQ:TSLA) rallied 3.4%, and Hewlett-Packard Company (NYSE:HPQ) staged a 2.8% rally. Stock investors are pulling back a little because they don’t want to lose money on a pullback, and Treasury bond investors are responding to a multi-year rally in bond yields.
Meanwhile, the United States economic picture remains strongly intact with low-growth, low-rates of inflation, rising consumer sentiment, and falling unemployment. The end of quantitative easing is indicating that investors should be buying the dollar (which is why the dollar-yen pair experienced such a strong rally).
How to position
I believe that the dollar-yen will eventually resume a longer-term uptrend. Currently there is little-to-no inflation in the United States. When the Federal Reserve raises interest rates, that will cause the dollar to rally against a basket of other currencies. It can be assumed that the amount of money chasing goods and services will decline, but because Japan has a lower discount rate there will be a larger pool of money chasing a smaller number of goods and services. Markets always trade based on perception and outward-looking assumptions that can be anywhere from two-to-five years away. Therefore, I remain a bull on the dollar.
I also believe that even if the stock market were to correct over the short term, and bond values were to increase, the rally in bond-coupon values will be temporary, and interest rates will continue to rise. The effects of this will be experienced over the course of many years. Rising interest rates could spark fears that the economy could weaken, but historically, GDP can grow in periods of high and low interest rates. Therefore, I believe that the United States economy will grow in an environment of rising interest rates.
Stock market
I think a diversified portfolio of stocks with reasonable rates of growth, modest valuation, and healthy dividends should be accumulated. In an environment of real economic growth, companies will grow earnings due to increasing rates of consumption.
Apple Inc. (NASDAQ:AAPL) is a really strong contender for a defensive portfolio. Currently the stock is extremely shareholder friendly. The promise of tomorrow is strong, and with more people entering the labor force, the amount of consumption for phone devices will continue to climb.
According to Piper Jaffray, 62% of teenagers plan to make an iPhone their next phone purchase. Taiwan Semiconductor Mfg. Co. Ltd. (ADR) (NYSE:TSM) projects that tablet devices will grow at a 23% annual compound growth rate over the next five-years. IDC estimates that the smartphone market will double from 2012 to 2016. Total unit sales of smartphones will increase to 1.4 billion.
Apple Inc. (NASDAQ:AAPL) is presiding in a favorable business environment; it is expected to take market share away from competitors and at the same time experience incremental revenue growth from new customers. The company also plans to markdown its iPhone in emerging markets in order to capture a larger amount of global market share and earn incremental revenue.
