On May 19th we made the comment that the deflationary winds are blowing. Recall that our broad theme here is that we need to make the right call on the inflation / deflation scenario, to correctly position our portfolios for the macro environment. Sure, security selection always matters, but macro drives the train.
With that always in mind, I urge readers to who aren’t already reading John Mauldin’s weekly letter, to spend some time with the June 5th edition There’s a Slow Train Coming (see blogroll link at right). One of the developments of recent years is that there is increasing skepticism toward the officially published economic data, so a number of very sharp analysts have taken up the challenge to bring us more data. Whose numbers are better is always up for debate, but we should always consider all the available information. John does a fine job of surveying that information and summarizing for us.
The data John shows us in this article are not encouraging for economic growth (or employment). Now, there is a large contingent of inflationists who insist that US fiscal and monetary policies, and the massive public debts, cannot but produce inflation. My own view is, when in doubt, watch the bond market. David Taggart has a nice post that shows us what’s going on in bond land. It’s unambiguously deflationary, or at best dis-inflationary.
So the question for the inflation hawks is, where is the evidence? The Fed and Treasury have been moving heaven and earth to produce a little inflation, and so far have come up empty. With monetary policy constrained by the zero rate boundary, fiscal policy constrained by the deficit hawks (real and imaginary), money supply falling, and core inflation threatening to go negative, Dr. Bernanke’s deflationary nightmares appear to be a real possibility.
Now, on to the more pertinent question, what all this means for us as investors. Well, if the deflationary view is right, it isn’t good for strategies that depend on growth or inflation – most stocks, commodities, TIPS. That scenario favors high quality bonds, cash, some conservative dividend paying stocks. This is what so many find hard to believe: how can bonds near all time low yields, or cash yielding nothing, be a good investment?
Well, look at it this way: a zero yield with a negative inflation rate = a positive real return, and safety of principal in an environment of falling asset prices is valuable. Put another way, when the stuff hits the fan, cash is king. I am not yet that pessimistic, and really do hope to see a better investing environment, but hope is not a strategy. Whatever comes our way, we have to see it for what it is, and be positioned to make the best of it.