Deflation investing?

[Architect]

All the investing books warn of the dangers of inflation and how to protect against it, but it's too bad none of them warn of the dangers of deflation and how to protect against that too. It would have helped a lot of people this year. For some reason the investing community relegated that to the tin foil hat corner, even though the evidence for it was everywhere.

Maybe it's instructive to review how its played out so far ...

1. Housing price deflation. Obvious one here - sell your house and rent, which was a great move in 2005. Housing is as much a financial decision as is investing.
2. Equity deflation. Own quality bonds - enough said.
3. Commodities deflation. It was wild to see everybody flipping over commodities last year - like they were the new undiscovered asset class. Commodities have always been far too volatile for you, me, hedgies, and institutional investors - what was different in 2007?
4. CPI deflation. This is the deflation everybody thinks of, which we're beginning to see now and could become more widespread.
5. Currency deflation. The strongest currency goes to the country with the highest productivity growth, traditionally the US which I expect to continue well into the future. One danger with overseas investing is you're not just playing with stocks, but currencies, and the buck bears have been slaughtered this last year.
6. Foreign equity deflation. It was also amusing to see everybody dogpile onto stocks everywhere else in the world, because when the downturn came it would trash those markets even worse than ours. The U.S. will probably be the best of a bad lot.

So how do you protect against deflation as an investor?

1. Stay out of debt. No news here for LBYM's investors ...
2. Own some Treasuries. The longer the better. Individual investors don't generally own the long bond, but sometimes it makes sense. Intermediate Treasuries won't kill you, and this year they've had a healthy return.
3. Be willing to give up potential gain to preserve capital. Tortoise vs hare kind of investing - would you rather be rich or retired? I'd rather have the retirement thank you, and give up the boat.
4. Never, ever believe that anything grows to the sky always and forever. Such as trees, skyscrapers, housing prices, college costs, medical costs, stock prices, inflation ...

Just a few thoughts, call me crazy, but maybe some people will find it helpful or amusing.

 

[chinaco]

I have not studied it as closely as inflation.

But you will want assets that can hold their value.

I think TIPS principal are adjusted downward until they mature so if you are hold them you might consider adjusting your portfolio accordingly. Of course, it may depend on how much of them you own and how long you anticipate the deflationary cycle to run.

IMO - These things are difficult to predict and time (like the stock market). That is why even in bonds it makes send to diversify. We hold some TIPS in our portfolio of bonds. And we know inflation is happening in certain areas (look at the SS increase, health care prices, cost of education, etc.)

Right now... It seems that the deflation is only occurring in certain areas (e.g. real estate). If it goes broader and last long... we might be in trouble.

Individual - TIPS: FAQs


I am interested in hearing what others think about this topic and how they might hedge against it.

 

[Meadbh]

How about land? They're not making any more of it, and you can grow food on it.

 

[Rustic23]

In the appraisal business it was often said that the most expensive thing to own is raw land. It produces little and due to taxes cost a bundle to own. Raw land is normally valued at the capitalized value of the cash crop. So a crop brining in $600 an acre would sell for $6,000. The closer the land is to development i.e. town or city the use changes and the value goes up. Other rural land has a value change based on trees, streams, lakes and other assorted amenities as the land gains value as second home sites. During deflation, land prices should fall right along with everything else.

 

[samclem]

I'd add one cautionary note: Don't go from one mania to another. Deflation is unlikely to be the new long-term trend, though that scenario is possible. Overweighting the "possible but unlikely" scenario (e.g. by loading up on LT Treasuries) could significantly increase the "far-more-likely" scenario (resumed inflation as the government prints money round-the-clock to "stimulizate" the economy).

As usual--balance and diversity will likely prove the most profitable (and sustainable) course of action. Abandonng equities now and locking in losses to pile into an 80% LT Treasury portfolio could be a big mistake if inflation goes to 10%.

 

[dex]

This is a good question. I don't have the answer to how to invest in a deflationary environment.
My only guess is cash, savings accounts and short term bond funds.

Maybe it is too late to adjust your portfolio for deflation and think about where to put you money to take advantage of the turnaround.

Tough question as to what to do.

 

[haha]

I'd add one cautionary note: Don't go from one mania to another. Deflation is unlikely to be the new long-term trend, though that scenario is possible.

I agree with this. Further, I believe that long term straight treasuries will likely be by far the worst investment class going forward. We have had fairly high inflation. Suddenly in the middle of a very severe credit crunch and a rapidly slowing economy, we get a few moths of rapid disinflation. Why do people expect that enough deflation will show up, and stay, to make long term bonds at < 4% anything other than a loser?

Don't be conned by government. The S&P cash yield tops l.t. treasuries, or at least it did last week before S&P rallied.

Ha

 

[Nords]

Deflation is unlikely to be the new long-term trend, though that scenario is possible.

Yeah, no kidding. Never underestimate the power of the printing presses of the U.S. government.

I think there's a wealth of economic research on how to avoid Japan's mistakes, and deflation-fighting tactics are probably well in hand.

 

[Rustic23]

Not an economist here, however, from what I remember it would seem like a trillion dollars plus in spending would be inflationary. However, stagflation was a term coined during the Carter era. Volker is given credit for raising interest rates to 20% to break inflation. If this happens again then it would seem like long term gov. bonds would be the place to be if we see that type of rise again. I remember reading a book, I think by Donnahue (sp), that said when bond rates exceed 10% your portfolio should be 100% fixed income.

 

[al_bundy]

deflation - bonds, government debt, other income paying investments, cash

inflation - gold, natural resources, real estate (not 100% sure about this)

 

[dex]

deflation - bonds, government debt, other income paying investments, cash

inflation - gold, natural resources, real estate (not 100% sure about this)

Al,
You left out the timing of when to buy these things.

 

[al_bundy]

July 2008, but i don't suggest buying bank stocks for the dividend

depends on which bear you believe, the we can't escape deflation bear or we will repeat the 1970's hyperinflation bear. i'm reading one of my newsletters now and it's saying Gold will hit around 1500 before it tops out with a possible downside target of 413 before it turns up again.

 

[lazygood4nothinbum]

yard (garage) sales

 

[Hamlet]

Does it really count as deflation if it is just bubble prices returning to normal?

I agree with this. Further, I believe that long term straight treasuries will likely be by far the worst investment class going forward. We have had fairly high inflation. Suddenly in the middle of a very severe credit crunch and a rapidly slowing economy, we get a few moths of rapid disinflation. Why do people expect that enough deflaion will show up, and stay, to make long term bonds at < 4% anything other than a loser?

Don't be conned by government. The S&P cash yield tops l.t. treasuries, or at least it did last week before S&P rallied.

Ha

 

[Gardnr]

Not an economist here, however, from what I remember it would seem like a trillion dollars plus in spending would be inflationary. However, stagflation was a term coined during the Carter era. Volker is given credit for raising interest rates to 20% to break inflation. If this happens again then it would seem like long term gov. bonds would be the place to be if we see that type of rise again. I remember reading a book, I think by Donnahue (sp), that said when bond rates exceed 10% your portfolio should be 100% fixed income.

If you're in LT bonds when interest rates go up as you describe you're going to get SLAUGHTERED. You want to be ST and then buy the LT when interest rates have topped out (if you can know that at the time; always the hard part). You'll then make a killing when rates start back down to "normal" range.

Be careful out there!

 

[FIRE'd@51]

Currently, we are in a period of asset deflation, but I wouldn't count on it being a long-term phenomenon when I look at this:

 

[Maurice]

I view the current deflation threat as a welcome buying opportunity for TIPS. I'll be in line for the January auction of the 20 yr.

Deflation is an overrated short term threat, IMHO, I'm more worried about inflation medicum and long term.

 

[Darryl]

Been buying TIPS for the last month in my Roth will also be inline in January buying 20yrs also. The Feds willingness to print money and inability to control spending will translate into inflation. I'm not sure when it will spike but I'll bet my money it's before 2029.

 

[Architect]

There are many deflationary forces in the economy presently. First, monetary creation hasn't gained any traction - the Fed is impotent. They can't even control the Funds rate, it's effectively zero when it should be 1%. I have personal doubts the Fed can take on the whole economy and arbitrarily create inflation, especially when we've fallen into a liquidity trap. The baby boomers have an average of $46k for retirement assets*, and little outside a rapidly deflating house. They've begun saving and should continue for a long while yet.

But my post is to offer some insight that there's more to deflation than just falling prices in the supermarket. Hedging or investing for deflation this last year would have been very profitable.

Something to cogitate ...

* Oops - this number is from last year before the crash ...

 

[barbarus]

The Fed congenitally fears deflation like they fear no other thing, probably including nuclear war. Therefore they will respond to the current economic debacle with hyperinflation. They will 'crank up the printing presses" and flood the world with cheap bucks.This is a grand thing for debtors who will be paying off their bills with dollars of declining value. It's an easy way to resolve the national debt for the government and it encourages rampant consumption.

Conversely, this is Hell on earth to savers, who will find their hard-earned funds worth less and less, with no way to grow their moneys value.