As concerns about deflation grow, where should you go with your investment dollars?
Deflation is a sustained period of falling prices.
Some analysts recommend that investors buy bonds, which can do better during deflation.
The problem with bonds right now is that the interest rates are extremely low. There’s so little downside to rates, and if rates climb the prices of the bonds could quickly drop. So fixed income could be a bad place to park your cash.
Some analysts are warning that the bond market may be in a bubble that could burst at some point when the economy rebounds and interest rates rise, leading to investor losses.
Instead, some experts are advising investors concerned about deflation to focus on the stock market, but stick with shares of relatively stable companies. That strategy can allow investors to capture some of the upside if the market recovers.
Among the recommendations: industries with better prospects for substantial cash flows, and companies like Johnson & Johnson and Procter & Gamble that trade at attractive prices and have sizable dividends.
Bill Gross, who runs the Pimco Total Return Fund, says that “you want the relative certainty of cash flows [from securities] like utilities and high-dividend stocks.”
Deflation is becoming a concern because signs point to a slowing economy. Last week, data on sales of both new and existing homes were so weak it startled analysts, part of the reason stocks came under pressure early in the week. But stocks shot higher Friday after Federal Reserve Chairman Ben Bernanke vowed to do whatever it takes to revive the shaky economy.
Fed officials don’t believe deflation is likely to happen, but Mr. Bernanke said in his speech Friday that the Fed would be proactive if inflation falls by a significant amount.
Deflation can occur when consumers and others have so much debt and so little savings that they find it harder to spend, encouraging companies to slash prices. That can worsen employment conditions, hurt corporate earnings and handcuff the economy.
Few experts have much experience dealing with deflation, which hasn’t been experienced for an extended period in the U.S. since the Great Depression. And it’s still quite unlikely — traders specializing in inflation derivatives say the market judges there to be less than a 20% chance of a period of deflation over the next decade.
Even if deflation doesn’t occur, some say investors should prepare for a period of slow growth and weak corporate profits.
In that kind of period, it’s important for investors to find investments that generate cash, such as dividend-paying stocks, preferred shares and master limited partnerships.
MLPs, which mostly are companies that own and operate pipelines primarily for natural gas and oil, usually trade at a dividend yield that is about three percentage points above U.S. Treasurys; today, with yields around 6.5%, the spread is close to four percentage points, making them look attractive.
The problem is MLPs have soared in price this year and may not have much more room to rise. And Alan Zafran, co-founder of Luminous Capital, a Los Angeles-based investment adviser, notes that if the economy takes a deep downturn and deflation is extreme, these companies may not be able to keep paying their dividends.
He prefers shares of Microsoft, Exxon Mobil and J&J, given their respectable dividends and ability to better withstand a downturn.
Some big investors are adding companies in safer businesses and avoiding those relying on discretionary spending, such as automobile, funiture and real-estate companies. “Stocks with a high degree of pricing power should do well, like health care, tobacco, utilities,” says Jack Ablin, chief investment officer of Harris Private Bank in Chicago.
Mr. Gross of Pimco cites P&G and J&J as examples of stocks with sizable dividends that also claim dependable cash flows.
Mike O’Rourke, chief market strategist at investment trading firm BTIG, says investors nervous about deflation should focus on pharmaceutical companies that “provide defensive qualities that pay you while you wait for a full economic recovery.” Merck, for example, has a dividend yield of 4.4%.
Another idea: Claymore/Zacks Multi-Asset Income Index fund (CVY). This exchange-traded fund puts its assets in stocks, real-estate investment trusts, MLPs, closed-end funds and preferred stocks that pay sizable dividends. It has a dividend yield above 5%.
Avi Tiomkin, chief strategist at Tigris Financial, a firm that owns shares of gold miners, says that gold is attractive in any period of deflation, arguing that companies in many industries will feel pressure to cut dividends. While most view gold as a hedge against inflation, not deflation, Mr. Tiomkin and some other hedge-fund investors view gold shares as a safer bet if deflation becomes more likely.
Some advisers say certain bonds might remain attractive as deflation appears more likely, but that investors need to be ready to exit the market swiftly if rates start to climb.
“You need to look at bonds tactically,” says Matthew Tuttle, who runs investment advisory firm Tuttle Wealth Management. “Enjoy the ride now but be prepared to get out.”
Related Information in Prosperity News
- How to Invest in Stocks, Bonds and Commodities For Deflation or Inflation
- Stock Dividends: Facts on What to Look For
- Gold: No Safe Haven
- Government Bonds – Should you buy TIPS instead?
- Net Worth: Four Ways to Build Wealth
- Wealth: After Market Decline, Next Steps
- Dollar-Cost Averaging: Slightly Lower Returns but Financial Protection
- Investing Internationally for Your Retirement Fund – Minimize Risk in Your Portfolio
