Every time markets correct you will often see a spate of negativity coming from the media over the direction of the stock market. You’ll often see long-range predictions that often involve a doomsday like scenario, or calls for a double-dip recession, another recession, etc.
Pimco states on its website:
High debt levels have raised the chances of a global recession in the next three-to-five years to more than 60%. The world economy goes through a recession about every six years, and the frequency of global recessions tends to rise when global indebtedness is high and falling compared with when indebtedness is low and rising.
One of the best leading economic indicators is US consumer sentiment. Generally speaking, when US consumer sentiment reaches above 90, you start reaching into recession territory as central banks will often pursue deflationary monetary policy in order to control the growth of the economy. Recessions sometimes are accidental (2007’s credit crisis), but, more often than not, monetary policy is the best predictive tool at determining whether or not an economy will correct itself.
The current monetary policy is aimed at reducing the Federal Reserve’s involvement in the open market, not an end to economic growth within of itself. This implies that the economy must grow in an environment of rising interest rates, which is concerning investors. This is because investors are not sure that housing demand will continue to trend higher in such an environment.
Ignore Pimco and buy stocks
In this chart, which begins in 1935, we can clearly see two things. First, interest rates rise and fall over really long periods of times, meaning that we could be entering our next super cycle of growth in an environment of rising interest rates. The historical data clearly supports the notion that an economy can grow in environments of both falling and rising interest rates.
During the 1900s, the lowest level the long-term interest rate reached was 1.9% (this was following the Great Depression). Chances are we’re likely in the up-swing of a rising interest rate, pro-growth economy. Rising interest rates should be seen as pro-cyclical as the long-term interest rates are at approximately 1.8%. Currently interest rates are lower than the post-depression-era. Since interest rates are at all-time-lows, there is a better risk-to-reward trade off with buying equities rather than bonds.
According to Pimco:
Investors should reduce their risk exposure given our outlook for deteriorating economic conditions in the world economy. In the equity space, we generally favor emerging market equities and specifically Chinese non-financial equities,
I believe just the opposite. An environment of rising interest rates paired with high levels of debt was already repeated following the Great Depression. After the Great Depression a period of economic prosperity followed, even with rising interest rates.
Over the next 10 years, it is more likely that interest rates will rise and that risk exposure should be increased, and fixed income exposure should decrease. Rising interest rate increases will cause bond note coupon values to decline, making it ineffective to be a buyer of bonds over the next 10 years.
Constructing an equity portfolio
Fixed income investors want to collect interest, but in the world of stocks that would be considered a dividend. Because of this, I believe that investors should buy a mix of income and growth stocks.
I believe that Apple Inc. (NASDAQ:AAPL) is a stronger contender for an income and growth-driven portfolio. While some may complain about the stock price volatility in this name, the potential growth should offset those concerns. Furthermore, I believe that the company’s long-term growth will continue.
Taiwan Semiconductor Mfg. Co. Ltd. (ADR) (NYSE:TSM) forecasts that the tablet market will grow at a 23% compound growth rate between 2012 and 2017. IDC estimates that the market for smartphones will double from 2012 to 2016, with total unit sales of smartphones at 1.4 billion.
Apple Inc. (NASDAQ:AAPL) will continue to monetize the success of its mobile product offerings over the next five years at a very reasonable growth rate. The company has been able to grow Mac sales in an environment of declining PC shipments, which implies that Apple Inc. (NASDAQ:AAPL)’s product strategy is superior to that of its competitors.
Apple trades at a 10.4 earnings multiple, which is reasonable in an environment of 20% to 25% projected growth in both tablets and smartphone devices. The company also compensates investors with a 2.8% dividend yield, and is also reducing share float with a $60 billion share-buyback program.
Investors can also find a safe haven in everyday-low price retailing giant Wal-Mart Stores, Inc. (NYSE:WMT). The company is experiencing currency headwinds, which hurt the bottom line earnings growth in its most recent quarter. However, the company’s retail strategy is continuing to improve within the United States, as comp sales were up by 1.3% in the domestic division. The company was able to grow earnings throughout the great recession, making it a solid investment in both good and bad times.
The company pays out a 2.5% dividend yield and is projected to grow earnings by around 9.5% on average over the next five years. The mix of yield and growth is likely to be sustained given the success of the company’s retail strategy over the past 50 years.
The Procter & Gamble Company (NYSE:PG) is another defensive player that investors cannot ignore. The company continues to return cash by buying back shares and at the same time growing sales of its most prominent brands in emerging markets. The company is a non-cyclical stock because laundry detergent, tissue paper, and mouthwash will always be in demand regardless of seasonality or economic recession.
Going forward the company is projected to grow earnings by around 7.2% on average over the next five years, and has a dividend yield of 3.1%. The company’s mix of yield and growth are compelling for those who want to beat the bond market with both equity appreciation and dividends.
Investors should stay the course in equities. Rumors of a potential economic recession should be disregarded as an economic recession isn’t likely to happen within the next two years. Calls for declining stocks because of an end of inflationary policy should also be ignored as the economy can grow during periods of both declining and rising long-term interest rates.
Investors coming from bonds into equities would do best by owning quality stocks that pay out a dividend.
Alexander Cho has no position in any stocks mentioned. The Motley Fool recommends Apple Inc. (NASDAQ:AAPL) and The Procter & Gamble Company (NYSE:PG). The Motley Fool owns shares of Apple. Alexander is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
The article Ignore Pimco and Buy These 3 Companies originally appeared on Fool.com and is written by Alexander Cho.
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