On Inflation, Deflation and 'Meflation'

|
 |  Includes: DGWIY, DIA, DYP, QQQ, SPY
by: Roger Nusbaum

A few things today.

First up is an article over the weekend from Jason Zweig. I usually don't agree with him very often (see this post and this one about emerging markets) but the current article explores an important concept and a clever term. The article talks about the battle between inflation and deflation and what investors should worry about it.

He says that investors should not worry about this and instead understand which outcome hurts them the most and prepare accordingly. He notes that for people in the accumulation phase of their life a little inflation is good because their asset prices generally appreciate, their mortgage gets paid off with cheaper dollars and their pay goes up. He believes a little deflation is good for retired people because their expenses can go down but their social security checks do not so their money goes further. For purposes of this post I'm not too concerned about debating him so much as the bigger picture implication.

He says that investors should worry about "meflation"; the outcome that threatens them the most. This is a point I've made before but in a slightly different context noting that the typical investor does not need protection against a Kudlowite outcome but they do need protection against a Roubinian outcome. Oh and for what its worth Zweig is still wrong about emerging markets.

Next up is the curious case of Duoyuan Global Water (DGW) which got the stuffing knocked out of it (similar to the beating Dan Doherty took from Captain Turner before turning the tables on the shockingly profane Deadwood) dropping 40% because, as Tate Dwinnell noted, related company Duoyuan Printing (NYSE:DYP) fired its auditor. DYP dropped by about 50%.

The particulars of the story are less interesting than the psychological litmus test this provides. If this is an out and out fraud then anyone buying right here and holding on will get wiped out, if this is a gross overreaction then anyone buying here stands to make a lot of money very quickly (no guarantee of course).

So with those stakes are you a buyer or do you avoid it? There isn't necessarily a wrong answer in that anyone comfortable buying this type of situation no doubt realizes that sometimes these win and sometimes they lose; this will be one or the other. Anyone leaving this one alone probably does not want the emotional hassle of enduring this. I have used the term know-thyself and this is a fantastic example of how to assess your own tendencies. Oh, and by the way: NO POSITION.

Yesterday someone with selective reading heckled me about the "futility" of using the 200 DMA as a triggerpoint for defensive action. I say selective reading because I talk incessantly about the goal being to avoid the full brunt of down a lot. The drag from a small position in a 2X inverse fund on a day that the market is up 1% is microscopic. If the market goes down a lot the hedging effect would be substantial, in my opinion.

Lost on the heckler is that the point has never been do what I do but figure out whether you, in the context of investing not trading, should take any defensive action and if so what is best for you. If ever there was case for staying on your own mat this is it.

Disclosure: None