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Apr 05

Deflation…how to invest?


Source: IMF

The above chart shows the IMF’s global inflation forecasts and they don’t look pretty. They are forecasting that advanced economies might by in a position of deflation similar to what Japan experienced in the 1990s. Many would argue that deflation is just as or almost as bad as high inflation. Deflation is simply the decline in prices and what this means is that if you as a consumer believe that prices will be cheaper tomorrow then you will not spend today and save your money. Not spending means lower revenue today, therefore costs need to be cut, jobs are lost, followed by less spending and the vicious cycle continues.

From an investment perspective, the above-mentioned vicious cycle results in declining profits which is therefore a negative for equities, credit, and as it often leads to near zero interest rates is not particularly good for cash either. The one asset class that is a good place to be in times of deflation are high grade bonds. Because inflation is the bond investor’s enemy, deflation is their friend. As interest rates, prices, and profits decrease during the deflationary cycle, high grade bond investors receive a fixed interest rate that doesn’t lose its purchasing power but actually increases it.

So whilst, governmet bonds had an incredible run in the 2008 calendar year, with deflation looking like a possibility in 2009 perhaps now is not the time to discount their value in a diversified portfolio.

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