Investing in Deflationary Times 20 comments
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“Deflation, The Economic A-Bomb: make no mistake, the most difficult problem we can face would be deflation. It is a virus in the economy that seizes upon the public mind and causes a vicious cycle of reduced spending, reduced production, and reduced profits. As Krugman recently noted, the deflation of the 1930’s came about during the interregnum between Hoover and Roosevelt. None of the downturns since the Depression has included deflation. Let us hope this one does not either.”
Now, just less than a month later, the jury seems to be decided. It is looking like deflation is exactly what is occurring in the U.S. economy and probably in many others. One tiny personal example: I’ve been planning to switch from a PC to a Mac for a few good reasons, but I don’t need to do it immediately. It’s about a $2,000 purchase all totaled, which I probably would have made just on an impulse in earlier times. But today I decided to put off the purchase and I shocked myself to discover why: It’s because I’m pretty sure that in a few months the Mac will be a few hundred dollars cheaper.
That is exactly the line of reasoning that creates and reinforces deflation. When people defer purchases because they expect lower prices later the economy slows further and thereby causes the lower prices people expect. That reality convinces more people that prices are falling and induces more deferral of purchases, etc. This virulent feedback loop cannot be reversed by standard Fed policy tools of lower interest rates and added liquidity. The only hope is to reflate via massive government expenditures. Unfortunately, the Bush administration has left the U.S. with gargantuan debts and deficits piled on during good times, so adding massively to them now is dangerous. That’s why deflation has put fear in the heart of the Fed and the Treasury.
What is the rational investment position to take during a deflation? Cash makes sense as do bonds because deflation, by definition, means that debts must be paid off in more valuable dollars. But there are two problems with owning bonds during a deflation. One is a heightened risk of bankruptcy for all entities, corporate and governmental, which could endanger the value of the bonds. Secondly there is some risk that the enormous expected efforts by the U.S. and other governments to re-inflate the economy could push us into inflationary times again. These two risks argue for cash. In a deflation your cash is worth more in terms of purchasing power as time goes on so there is some inherent return to cash even if there is little or no interest income.
Inflation, the opposite problem and the one with which we have more experience, is favored by governments because it allows them to pay back their debts in less valuable dollars. It is also favored by investors and has been the primary condition of the economy during nearly all of the period since 1982 during which stocks have experienced superior returns. A mild inflation makes it cheaper for corporations to borrow to fund their operations because they pay back the debts in cheaper dollars. Inflation also helps them show growth. Both conditions increase earnings more rapidly. So as a general rule, it makes sense to own stocks during a period of gentle inflation but not during a period of deflation.
I am astounded by the speed at which the global economy is deteriorating. In November the Japanese economy imported 17% less oil as exports declined 27%, both y/y. European industrial orders declined 15% y/y, the worst on record. GM and Chrysler have closed all plants for at least a month, perhaps permanently in the case of Chrysler. Toyota (TM) has reported its first loss on record citing the global economy. Stores are offering discounts before Christmas that exceed what they used to offer after the holiday. Companies are starting to reduce salaries to avoid having to fire people.
Just one month ago the Fed began drastic actions aimed arresting potential deflationary forces. Now it seems like they have either been decisively defeated in that effort or are substantially at risk of defeat. Moreover, the trend toward deflation seems to be moving around the world, impacting nearly all economies.
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This article has 20 comments:
Banks are hoarding, and don't want to lend. Consumers are hoarding, and don't want to borrow or buy. Companies are hoarding, and contracting or vanishing.
Cash is king, unless the dollar plummets vs. alternate currencies, but no country wants to have a stronger relative currency, because of exporting product issues to their economies ( certainly not China or Japan ).
On Dec 23 12:03 PM lark wrote:
> How long will be this deflationary times. There are a lot of money
> that is printed.
I'll go ahead and put my two cents in. There are two areas that I think are worth investing in, and one of those areas is now down to a single company: Ford. Normally I don't care to name individual companies in this kind of forum, but as the strongest of the big three I believe Ford is in a position to see significant gains as soon as the economy starts picking up. News stories about the big three bailout have also provided free publicity for Ford Motor Company-specifically the fact that in recent reliability tests some Ford products are on par with Toyota and Honda in Initial quality surveys. Last I checked Ford stock is all the way down to 2.18 a share, and at that price I think it's a pretty safe bet. Just expect a long-term hold, this one won't pay off for awhile.
Another area that I see as strong are private label food brands. This is a pure "social utility," pick; if people are looking for ways to save money, invest in those alternative products that they will turn to when they want to save money. Private label brands are the companies that manufacture grocery items and label them for different regional grocery chains. Many of these private label brands are now producing items that are on par with national brands for quality, but at significantly cheaper prices. I shop at Wegman's grocery stores, an upstate NY chain, and I feel the quality of their store brand items is always at least as good, if not better than the national brands.
Finally, local entrepreneurs. I really think now is the time for investors to start "going out on their own," and looking for ways to provide start up capital for local small businesses. You have to be a real shark to do this properly. If you're prone to sales pitches this is the worst possible area of investing for you. A good rule of thumb, if you pay your credit cards off every month, or just generally don't use credit cards at all, then you might want to consider the local entrepreneur angle. If you carry a significant balance, then you're too green, you'll most likely end up losing your shirt.
On Dec 23 12:18 PM LilBob wrote:
> I have to agree with Alan. There really isn't any investing advice
> here. Not even a reiteration of the "Buy Low and Sell High," philosophy.
>
>
> I'll go ahead and put my two cents in. There are two areas that I
> think are worth investing in, and one of those areas is now down
> to a single company: Ford. Normally I don't care to name individual
> companies in this kind of forum, but as the strongest of the big
> three I believe Ford is in a position to see significant gains as
> soon as the economy starts picking up. News stories about the big
> three bailout have also provided free publicity for Ford Motor Company-specifically
> the fact that in recent reliability tests some Ford products are
> on par with Toyota and Honda in Initial quality surveys. Last I checked
> Ford stock is all the way down to 2.18 a share, and at that price
> I think it's a pretty safe bet. Just expect a long-term hold, this
> one won't pay off for awhile.
>
> Another area that I see as strong are private label food brands.
> This is a pure "social utility," pick; if people are looking for
> ways to save money, invest in those alternative products that they
> will turn to when they want to save money. Private label brands are
> the companies that manufacture grocery items and label them for different
> regional grocery chains. Many of these private label brands are now
> producing items that are on par with national brands for quality,
> but at significantly cheaper prices. I shop at Wegman's grocery stores,
> an upstate NY chain, and I feel the quality of their store brand
> items is always at least as good, if not better than the national
> brands.
>
> Finally, local entrepreneurs. I really think now is the time for
> investors to start "going out on their own," and looking for ways
> to provide start up capital for local small businesses. You have
> to be a real shark to do this properly. If you're prone to sales
> pitches this is the worst possible area of investing for you. A good
> rule of thumb, if you pay your credit cards off every month, or just
> generally don't use credit cards at all, then you might want to consider
> the local entrepreneur angle. If you carry a significant balance,
> then you're too green, you'll most likely end up losing your shirt.
Jim's example may be deferral, but look around, it s not just deferral, its a seachange in consumer attitude.
On Dec 23 12:53 PM The Divagator wrote:
> Deferral of purchases does not equal deflation. Your computer anecdote
> is not convincing. Until folks in the deflation camp reconcile deflation
> with the current rise in the money supply, it is hard to take the
> argument for deflation very seriously.
My turn -- in the energy sector I like Husky (TSE: HSE), a great E&P independent in all the right places, doing all the right things.
No one wants to say it but we are in deflation which will take many years to correct. Govt. spending does not help. By 1939 20% of US workers were still with out meaningful jobs. Japan took 15 years and is still in deflation.
On Dec 23 12:12 PM patio wrote:
> What if they gave a printing party, and nobody came?
On Dec 23 02:42 PM patio wrote:
> Until the rise in money supply camp takes into account the lack of
> rise in velocity, it is hard to take their argument seriously. <br/>Jim's
> example may be deferral, but look around, it s not just deferral,
> its a seachange in consumer attitude.
It is a good time to look at foreclosures.
A buddy of mine and I went halves on Twenty Four acres, 2,700 sq. ft.house, huge shop, double bay RV building with roll-up doors, in-ground pool encased in a cedarlined building, with change room and bathroom. The south facing property with spring for irrigation, huge classic barn, 30 miles from Olympia Washington, ideal for Ag. Got it for $ 132,500 each -- enuf room to run 10 head of Angus-3 acres of Blueberries and 5 acres of Noble Fir for Xmas trees= yearly net of around $ 25,000 in SPARE time.
Banks want non-performing stuff off the books -go in and lowball the bast*rds.
Time to get FARMLAND REPOS !!!
---- time to buy when fear folds the timid.
To those that say Deflation----So many people Worldwide, finally have the ability to make better in thier lives only to be snuffed out by a Wall Street phoney baloney derivative scheme is tragic.
However; it isn't going to happen - the future may seem bleak here & now, but 2.5 billion people got a good taste of capitalism and they aren't as morally challenged as we. Specifically those souls in India and China do not ride on our back anymore.
Canada, Australia,and Brazil ARE the major players for resources, the market;China & India aren't going away anytime soon. It will be they that bring on the new world order. For the USA, hardtime, and decline, until we learn the value of money again. We will be the last ones out this time round.
There are so many great dividend paying foreign companies out there,
big prosperous companies, dirt cheap.
(EWA)etf, COSWF,YZC,GFI,FCX,BBD,... SU (oilsand leader)
& China has so many great small drug,technology,energy... consumer products companies. snen,chng, wx, wh, watg, ssrx, jst, ampr,sol, sdth ,etc etc...
Have you thought about buying Ford debt? Longer, high coupon senior unsecured can be bought around 20 cents on the dollar. If for survives 2.5 years, you've made your money back, the rest is pure profit. If they do reorg, you will own the stock anyway.
1. Seeking Alpha left out the first sentence of my essay. For the original, see my website: energyinvestmentstrate....
2. For those who said that I didn't offer an investment conclusion: did I not specifically say that in a deflationary environment the two investments that make sense to me are bonds and cash? What could be more plain? That means "no stocks".
3. It's interesting to read what specific investments make sense to others. On Ford, I agree they look like the most likely survivor among the Detroit 3 at this point and they seem to have better management than GM or Chrysler (which does not say much). But please note that Ford is in debt up to and perhaps beyond its capacity to handle the debt. That capacity will tend to decrease in a deflationary environment when dollars buy increasingly more and are thus harder to come by. I don't think my first choice among equity investments would be a highly leveraged company. In a deflation you do not want to be indebted. It is only during inflationary times when debt is a good thing to have because it leverages the rising asset values that it finances. In deflation the asset values tend to fall - that's one thing that makes it a deflation - so debt just leverages the decline in value. You don't want to finance falling asset values with fixed amounts of debt. In fact, you don't even want to own assets. That's why cash is the preferred investment during deflation.
We have indeed tried to inflate the money supply and this can be seen in bank excess reserves. But that's all it is right now. It has not been lent out. As a previous poster has mentioned, we need not be concerned with price inflation until excess reserves find their way into the real economy. Then consumer confidence must turn around. Then the Fed's plan to sop up excess dollars (if they have one) must fail. I happen to think that day is coming.
Nice article, Jim. I thought your point about cash and bonds was pretty straightforward.
Quite simply, it smacks of HERD MENTALITY, where everyone is confortable assuming that because a trend is underway (in this case Deflation) that it will continue forever - because it is, after all, self-perpetuating and in likelihood can only continue in perpetuity.
Remember the Internet Bubble?; remember the Real Estate Bubble?; Remember forecasts of oil going to $200 by so-called "experts"; now, because of a serious correction, "expert" forecasts are calling for $30 or lower crude oil prices. Why not $5.00 oil, in total disregard for supply/demand factors? Yeah - right...?. Similarly, why not assume that we'll return to the horse-and-buggy days and exchanging a bunch of carrots for a pound of sugar.
True, there is that element of negative feedback and creeping reinforcement in the perception of consumers and investors regarding prospects for the world economy at the moment - which can't be denied as being quite relevant to the current situation. It's human nature to seek safety. But it's also quite naive to assume that human ingeniuty will not prevail.
A half-century in the stock market and twenty years as a full-time investor leads me to suspect that a simplistic view accomplishes little except to perpetuate a problem. It's relevant to note that the severity of the recent market decline probably discounts much if not all of the evolving, dismal, economic developments.
No, I'm not pounding my drum here; just invoking common sense based on experience. The world and the economy as we know it is not approaching its final days, as perhaps some of the bible-thumpers (and more than the odd economist) would have you believe. Bubbles - take your pick - are driven by mass histeria and so are the inevitable corrections - such as we have today. We'll get over it, and emerge the better for our hard knocks - it's called experience.
In the end, the investors who will profit are the ones who can take defensive action in the face of a serious threat, but then muster up the courage to stand on the merits of their own sensible (and informed) evaluation - making a commitment when few others will. Blindly adopting the ill-founded opinions of others seldom, if ever, produces a desirable outcome.
It might seem trite, but consider this: begin with a conclusion, either your own making or as presented by someone else, and you'll easily rationalize yourself into believing it! Dangerous stuff when it comes to investing in the stock market, in my opinion.
Just a thought....Best wishes for the Season, and for your investment portfolio.
Deflation means-prices are going back to where they belong-to actual value. Inflation is caused by craziness-folks buying houses as an investment rather than as a place to live, all of which creates turnover
and the resultant construction than what the economy can bear.
www.federalreserve.gov...
He didnt think it was a threat because our financial system was strong. lol.
On Dec 24 06:15 PM User 179191 wrote:
> Interesting article; and lots of relevant and well-considered reader
> comments. But I do have a problem with this article and the many
> comments! (And to almost every blog I've read in recent months.)
>
>
> Quite simply, it smacks of HERD MENTALITY, where everyone is confortable
> assuming that because a trend is underway (in this case Deflation)
> that it will continue forever - because it is, after all, self-perpetuating
> and in likelihood can only continue in perpetuity.
>
> Remember the Internet Bubble?; remember the Real Estate Bubble?;
> Remember forecasts of oil going to $200 by so-called "experts"; now,
> because of a serious correction, "expert" forecasts are calling for
> $30 or lower crude oil prices. Why not $5.00 oil, in total disregard
> for supply/demand factors? Yeah - right...?. Similarly, why not assume
> that we'll return to the horse-and-buggy days and exchanging a bunch
> of carrots for a pound of sugar.
>
> True, there is that element of negative feedback and creeping reinforcement
> in the perception of consumers and investors regarding prospects
> for the world economy at the moment - which can't be denied as being
> quite relevant to the current situation. It's human nature to seek
> safety. But it's also quite naive to assume that human ingeniuty
> will not prevail.
>
> A half-century in the stock market and twenty years as a full-time
> investor leads me to suspect that a simplistic view accomplishes
> little except to perpetuate a problem. It's relevant to note that
> the severity of the recent market decline probably discounts much
> if not all of the evolving, dismal, economic developments.
>
> No, I'm not pounding my drum here; just invoking common sense based
> on experience. The world and the economy as we know it is not approaching
> its final days, as perhaps some of the bible-thumpers (and more than
> the odd economist) would have you believe. Bubbles - take your pick
> - are driven by mass histeria and so are the inevitable corrections
> - such as we have today. We'll get over it, and emerge the better
> for our hard knocks - it's called experience.
>
> In the end, the investors who will profit are the ones who can take
> defensive action in the face of a serious threat, but then muster
> up the courage to stand on the merits of their own sensible (and
> informed) evaluation - making a commitment when few others will.
> Blindly adopting the ill-founded opinions of others seldom, if ever,
> produces a desirable outcome.
>
> It might seem trite, but consider this: begin with a conclusion,
> either your own making or as presented by someone else, and you'll
> easily rationalize yourself into believing it! Dangerous stuff when
> it comes to investing in the stock market, in my opinion.
>
> Just a thought....Best wishes for the Season, and for your investment
> portfolio.