There are news articles all over the places to sell stocks as the Dow and S&P make their new peaks. The Dow recently crossed the psychological barrier of 15000 and now pessimism is everywhere to sell the stocks and be in cash for a favorable entry if the market pulls back.
When will the market pull back? No one know that answer for sure but everyone has their own opinion about it. Below are the few points that I feel the Dow or S&P will be at this level or higher in short term.
Pull back on Gold and TIPS.
A recent pull back on Gold and TIPS indicate the markets are expecting a deflation in short term. Although the Gold sell off was partially triggered due to Cypriot decision to sell gold to pay down its debt and the hope for other debt laden European nations to follow but some of the pullback can be attributed to lower inflation environment. The spider gold ETF GLD is down by 15% YTD and was followed by iShares SLV which is down by 22% YTD.
The iShares TIP is down by 1.15% and is close to hitting it 52 weeks low. This indicates Wall Street is expecting a low inflation environment. Under a low inflation environment the TIPS holders will lose money as they bought the TIPS at very low yields with expectations of high yields in future due to inflation.
Central Bank Actions
A recent headline from Fed indicated the plans being discussed to stop the bond purchase program. I think it's just the planning and it won't stop the bond purchase until there are indications of global GDP growth. The ECB and central banks did a rate cut last month and bond purchase from Japan pushed the Dollar higher. Some emerging economies like China and India could cut rates as the growth slows down. Under these circumstances if the Fed stops the bond purchase program or even hints a rate increase, the Dollar would go up reducing the inflation further and make US exports uncompetitive.
The unemployment rate continue to go down that would help the overall economy to stabilize. Although more people are getting back to jobs, the income are not rising. With no improvement in real income we won't see much demand for goods and services and have a very low inflation in short term.
What to buy?
I would continue maintain my position in equity until Fed finally stops buying bonds. Bond purchases are simply boosting the asset prices across most of the asset class. As long as Fed keeps its purchase program the Dow and S&P index will continue to rise even with poor earnings. The spider S&P (NYSEARCA:SPY) is up by 15% this year.
Solid Balance Sheet companies
Companies with Solid balance sheet and with a lot of cash and short term investment like Apple (NASDAQ:AAPL) and Wal-Mart (NYSE:WMT) are a good fit in this category. Apple recently sold debt to increase dividend and share buyback to reward its shareholders. The EPS would continue to go higher due to the share repurchase programs and hence would provide stability to its stock price.
Companies selling products with low elasticity.
Companies which would continue improve revenue even in a deflationary environment and hence generate free cash flows to either buy their own stocks or pay dividends like Johnson & Johnson (NYSE:JNJ) and GlaxoSmithKline PLC (NYSE:GSK).
Growth Stocks perform well under a deflationary environment as these companies are not dependent on the economic cycle.
What to Avoid?
With most of the Europe already in recession and slower growth in emerging economies, I would avoid all commodity and energy stocks even the ones that pay high dividend as those get pressurized if inflation expectation cools off.
Disclosure: I am long JNJ, AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: It is not a recommendation to buy or sell any stock. Individual situations can vary and a single investment advice is not suitable for all. You must consult with your financial advisor before making any purchase.