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Nickelless
Administrator
USA
5580 Posts |
 Posted - 12/07/2008 : 22:32:23
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By Gail MarksJarvis
Tribune staff reporter
The unnerving word of the day is "deflation."
It's the watchword in countless reports recently from economists and investment strategists. As Merrill Lynch economist David Rosenberg said in a note to clients last week, "If there is a message coming from the markets, the data and the Fed-speak of late, it is the growing risks of deflation."
At first blush, deflation doesn't seem so bad. It means that prices are falling as demand drops for products such as oil, electronics and other items. For the consumer, of course, that probably comes as relief--an opportunity to fill your gasoline tank without emptying your wallet or a chance to finish your holiday shopping by hopping from half-off sale to half-off sale.
But the concern about deflation focuses on the possibility of a spiral, when a trend of decreasing prices feeds on itself and leaves consumers and businesses in a sorry state.
At first, prices decline because the economy is slowing and people and businesses cut back on purchases.
As they do, businesses try to attract customers and clear out products by offering lower prices. As they reduce prices, however, companies are pinched because they have debts to pay for previous purchases, payrolls to cover, costs to run the business, and perhaps a glut of unsold products.
So they cut back on spending where they can and lay people off. As people lose jobs, or worry about losing a job, they cut spending, and businesses are hit again by declining demand from customers. As a result, the pressure to cut prices rises. And in a nasty spiral--like Japan in the 1990s--people become accustomed to prices dropping and they see no urgency to buy. With demand slipping, prices drop further to persuade people to buy, and businesses suffer more.
Americans have little experience with long periods of deflation. Still, strategists are looking at the possibility of deflation so they can guide clients through both stock and bond investments. A simple rule of thumb is to avoid stocks and bonds from companies with heavy debt or those that need to borrow significantly to fund operations.
Even without the pressure of the current credit crunch, debt is the enemy when companies or individuals must pay it off when money may be more scarce. Consequently, financial planners have been urging people to pay off credit cards and auto loans, while building up emergency savings in case of an extended job loss.
For investors, a period of deflation could be treacherous. Market analysts at Ned Davis Research studied a serious bout of deflation, and found that between August 1929 and June 1932, consumer staples--or companies that made products like toothpaste and footwear that people need--held up better than most stocks. But even they declined 50 percent, said Lance Stonecypher, a Ned Davis strategist.
Companies punished by the cycle of weak demand and falling prices declined far more. Iron and steel company stocks dropped 90.7 percent, department stores dropped 90.9 percent and automobiles dropped 89.4 percent. The worst-hit area was aerospace and defense, which dropped 95.7 percent.
"Industry selection provides only limited protection," Stonecypher said.
He and other researchers said it's premature to think the current cycle might be like the 1930s. The potential for an economic stimulus package could dampen any threat.
In fact, some experts think the market could be nearing a bottom.
If that's true, investors need to be cautious about the sectors they choose. After a bottom, the stocks that held up best in the downturn can end up falling hard, Stonecypher said.
Investors also must be cautious about buying U.S. Treasury bonds for safety, Rosenberg said. As people have poured money into Treasuries for safekeeping, yields have fallen to historic lows.
"Never before have we fielded so many calls from financial advisers asking us if they should be dipping into the Treasury market right now, which leads us to believe the rally is overdone," Rosenberg said. If he is right, that could mean investors could lose money on the bonds.
Some advisers are steering risk-averse clients into certificates of deposit, rather than Treasury bonds, because CDs pay higher interest, are insured by the government and won't decline in value if investors anticipate interest rates rising.
Meanwhile, the Leuthold Group noted that investors do not need to fear mild periods of deflation. In only seven of 31 instances of mild deflation since 1926 did the stock market decline. In 19 periods of mild deflation, the Standard & Poor's 500 actually gained more than 20 percent.
Gail MarksJarvis is a Your Money columnist. Contact her at gmarksjarvis@tribune.com.
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pencilvanian
1000+ Penny Miser Member
USA
2209 Posts |
Posted - 12/08/2008 : 20:21:00
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A great find Nickelless, and if I may, I would like to add to this post with a few quotes from two authors who are smarter than the "smartest guys in the room" in the Fed or Wall Street (then again, who doesn't have a higher IQ than these dullards in the Fed or the Street?)
Concerning inflation-
“Like the generals who built the Maginot Line, the deflationists are fighting the last war. Because the American decision making generation is still re-living the last great deflationary depression of the 30’s, our most predictable reaction will always be to inflate the currency to fight deflation and depression,...The people who propose that we will allow deflation simply do not understand politics or the human equation. Governments will spend more than it collects in taxes and the federal reserve will accommodate their inflationary money requirements.”
P.56
How to Prosper During the Coming Bad Years
printed in 1979 by Howard J Ruff
Then and now, the fear of deflation will force the governemt's hand to fight deflation/recession/depression full force.
Concerning the big downturn in stocks in the 30's-
“It was mob psychology, and it was not, primarily, that the price level of the market was unsoundly high…the fall in the market was very largely due to the psychology by which it went down because it went down. “
P.179
The Money Game
By Adam Smith
A K A George J. W. Goodman
Fear drove the market, investors fled for their financial lives and it would be decades before investors would consider stocks anything other than extremely risky or crooked.
Many of the stocks back in 1929 were the granddaddys of the dot com era, no profits, no products, few if any sales, just potential to bring about the next big thing in aircraft, electronics/radio, household appliances, etc.
I guess it is true there isn't anything new under the sun. |
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Column: Concerns about deflation have some on edge
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