Wednesday, September 15, 2010

How to Invest in a Deflationary Environment

morningstar.com,

Question: I've been reading a lot about deflation recently and am worried. Will any investments hold up well in a deflationary environment?

Answer: Although inflation grabbed all the headlines less than a year ago, it's downright tame right now. Instead, some market participants are concerned that we could confront a period of declining prices as the government's stimulus package winds down, particularly if unemployment stays high and the housing market stays in the doldrums. Some investors, such as DoubleLine's Jeffrey Gundlach, have argued in the past that deflation could be a near-term problem, followed by high inflation rates down the line.

Why It Hurts
At first blush, declining prices for stuff may not sound that bad, particularly for consumers who might be able to take advantage of lower prices for everything from groceries to LCD televisions. But a persistent need to slash prices can be bad for businesses and could ultimately lead to layoffs, reduced consumer spending, and declining prices for a broad swath of assets, from real estate to commodities. Those forces, in turn, could put pressure on corporate profits and stock prices.

Inflation is a force to be reckoned with, too. But it's deflation that really makes economists shudder. (more)

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