Five Things You Need to Know: Investing for Deflation
What goes up when everything is going down?
1. Investing for Deflation
Earlier this week someone asked me the following very good question:
My question is related to your article on deflation. I've heard this tug-of-war regarding inflation versus deflation, and I see both sides of the debate. It seems like you would suggest there will be some (potentially long) period of deflation, with inflation coming later. My question is simple:
How do you invest to profit (or at least minimize losses) during a period of deflation? Any buy-and-hold sorts of things you can add to a portfolio to hedge against deflation?
Conventional wisdom is that there is always something to buy in a bear market and sell in a bull market. However, if the long-term deflationary debt unwind thesis is correct, the point of recognition will result in the simultaneous decline of virtually all financial assets.
Under those circumstances, shopping for bargains among the rubble is like groping around in a pile of knives. This is a difficult concept to grasp, especially given the length and magnitude of the secular bull market in social mood and, subsequently, financial assets, that brought us to this point. But the reality is that during a deflationary debt unwind there are no good long-term investments other than cash.
2. The Microsoft View
While the fate of financial assets in a deflationary depression makes for grim reading, keep in mind that not every business fails... not every worker loses his or her job... life does go on. In fact, the enduring lesson from the Great Depression is that it eventually ended... despite the role of government in prolonging and exacerbating it.
That's why I was interested in reading Microsoft (MSFT) CEO Steve Ballmer's recent comments to the U.S. House of Representatives Democratic Caucus Retreat in Williamsburg, VA.
Ballmer's remarks were sobering and realistic without being defeatist.
"In my view, what we now have will be a fundamental economic reset," Ballmer said. "This is a once-in-a-lifetime economic crisis," he added later in his remarks. "There is a lot of history around that, and frankly if you stop and think about it, 1837, '73, '29, 2008, it's almost exactly a whole lifetime between each of the major economic difficulties that we face. But I think it's also a once-in-a-lifetime opportunity to think about our priorities again and make the investments that put us on the right foot."
3. How Must the Economy "Reset"?
There are three things that must happen for this economic reset to complete, Microsoft CEO Steve Ballmer said in his remarks at the U.S. House of Representatives Democratic Caucus Retreat.
1. The economy must be deleveraged and private debt as a percentage of GDP must be reduced.
2. Confidence must be restored.
3. America must return to growth built on innovation and productivity rather than leverage and debt.
I wholeheartedly agree on points one and three, both things I have written about extensively over the past three years. But point two is far more problematic. This is because of where we are in the transition from positive to negative social mood.
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