Deflation: The Experts’ Latest Scare Tactic

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 |  Includes: DIA, IVV, IWB, IWM, IWV, QQQ, SPY
by: John Tobey, CFA

The big, bad forecasts refuse to die. It’s time to shoot (i.e., ignore) the messenger. We need to focus on what is really happening, not the latest scary scenario being pushed by an investment manager.

The people furnishing frightening visions are not altruistic. When some wise investment manager issues a warning, question the motive – guaranteed, it’s not to help us. They have taken positions, and now they want to encourage investors to help those investments pay off.

The record is dismal, so why listen now?

Based on past, scary outlooks, unemployment should be 11-12% or higher, banks should be reeling under massive individual and commercial real estate foreclosures, consumers should be hunkered down and interested only in their savings accounts, and corporations should be struggling to make a profit as the economy sinks to or below its previous lows.

More recent dark visions had Greece/Europe/Euro collapsing, Goldman Sachs’ SEC lawsuit leading to dramatic financial revelations and BP’s oil spill working its way around Florida while adversely affecting the energy industry.

Moving on, the fear factories are producing deflation frights:

“Some of the world’s leading investors are becoming more worried about deflation and are re-shaping their portfolios to prepare for a possible period of falling prices.

“Bond-fund heavyweight Bill Gross, investment manager Jeremy Grantham and hedge-fund managers David Tepper and Alan Fournier are among the best-known investors who are bracing for a possible bout of deflation, a development that could cripple global economies and world stock markets.”

(“Big Investors Fear Deflation,” The Wall Street Journal, “Abreast of the Market,” by Gregory Zuckerman, August 2, page C-1)

“Cripple global economies and world stock markets.” Really? So, in one month we have moved from government deficits/debts’ inflationary fear to government frugality’s deflationary fright? This is a pendulum out of control.

The right approach by the right group

James Bullard, president of the Federal Reserve Bank of St. Louis, recently discussed what the Fed is up to and the issues they are wrestling with. He puts deflation in its proper place, along with other possible problems – as risks that the Federal Reserve must understand and be prepared to tackle if they occur:

“… Mr. Bullard said he didn’t believe the Fed should reopen the security-purchases program that it concluded in March, but it should be prepared to do so if more extreme deflationary threats arise.

“’This is a matter of being ready in case something else hits…. What if there’s a terrorist attack? What if there is some kind of trouble in the Asian recovery or something like that?”

(“Fed’s Bullard Cautions on Low Rates,” The Wall Street Journal, by Michael Casey, July 30, page C-3)

Ignore the wild forecasts – focus on the facts

Meanwhile, in other news, exciting stuff is happening. Much of it points to potentially good stock market profits. Here is a sampling of the latest reports:

  • Company earnings reports are good, highlighting successful strategies
  • Business spending (investing) is up, particularly on technology
  • Cash flow is so good it is also being used to repurchase shares
  • US manufacturing executives are more upbeat: 70% expect revenues to rise and 45% expect to increase employment (KPMG International survey: “Sustained business recovery on the cards as companies look to re-start investment”)
  • Corporations are actively raising money by issuing bonds at low interest rates

And here are outstanding reports from two of America's largest companies:

  • The first is Exxon’s (NYSE:XOM) discussion of their activities and how things are “progressing full speed ahead” and the company’s diversification is paying off: “Refining Rebound Lifts Exxon’s Profit – Higher Commodity Prices, Output Help Drive Oil Giant’s Earnings Up 91%; Gulf Drilling Moratorium Has Scant Effect” (The Wall Street Journal, by Isabel Ordonez, July 30, page B-3)
  • The second is from Coca-Cola (NYSE:KO):

“Coca-Cola uncapped the most surprising outlook of the earnings season: ‘North America will be a growth market of great opportunities for the next 10 years and beyond.’”

(“Can Coca-Cola Quench Investors’ Thirst?Barron’s, August 2, page 12)

So… Ignore the doomsayers. They’re simply using scare tactics to make a buck. Rather, follow the other buck-makers: US corporations. They can produce good returns for owners (shareholders) through sound, positive activities.

Disclosure: Client positions in KO, XOM