How to Prosper during Market Volatility

Alexander is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

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.

<img alt="" height="478" src="http://g.fool.com/editorial/images/49851/6-12-13-macro-pic-1_large.png" width="725" />

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, DuPont, and Johnson and Johnson.

At the same time, high-volatility, high-beta names like Tesla Motors rallied 3.4%, and Hewlett-Packard 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 (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 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 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.

The stock pays a 2.8% dividend yield and trades at a 10.3 earnings multiple. The iPhone 6 product refresh cycle is going to release some pent-up demand for Apple products.

Macy’s (NYSE: M) is a stable yielder in an environment of economic growth. During the market crash and bottom of 2009, the stock performed slightly worse than the broader stock market. But during periods of economic growth, the company’s stock returns out-perform the stock market.

The stock’s price behavior offers a superb risk to reward during periods of economic expansion. The company carries a whole host of brands like Ralph Lauren, Gucci, Calvin Klein, Levi’s, and etc. These luxury brands aren’t going out of style anytime soon. Let’s not forget that kids love Justin Bieber, and in extension love Macy’s (Justin Bieber endorses Macy’s).

Analysts on a consensus basis anticipate Macy’s to grow earnings by 14.2% in fiscal year 2013, and 13.2% in fiscal year 2014. The high rates of growth are also accompanied by a 2.1% dividend yield. The company trades at a 14.1 earnings multiple, which is reasonable based on the projected growth.

General Electric (NYSE: GE) is another compelling investment opportunity. The company is globally diversified in a bunch of different industrial segments. Its growth is generally cyclical, and a large component of that performance is driven by demand in airline travel, which has a high income-elastic rating of 5.8. Using that rating we can assume that when income grows by 10%, demand for airline travel goes up by 58.1%. In an environment of global prosperity and rising incomes, General Electric’s aeronautics segment is favorably impacted.

The company plans to divest and spin-off its GE Capital division, which could free-up some capital on the balance sheet for more productive uses than lending. Going forward, the company plans to grow earnings through a mix of acquisitions, share buybacks, emerging market growth, and via the development of industrial business segments. The company is projected to grow earnings by 10.9% on average over the next five years. The company also pays its investors a 3.2% dividend yield.

Conclusion

In an environment of stock and bond market volatility, you want a team of stalwart stocks that will deliver sustainable growth. I believe that Apple, General Electric, and Macy’s will generate a reasonable mix of growth and income over the next five to 10 years.

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Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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