In the short term, the world’s economies will not have to worry about inflation. The drop in demand for goods and services is causing prices to actually drop. This disinflation will not last long since the supply is still constrained. As demand picks up again, especially in the emerging economies, inflationary forces will emerge. The U.S. government’s stimulus programs will actually add to the inflationary forces in the future. In the short term these forces will lead to reflation, which is the reappearance of a rising inflation rate. Reflation is not undesirable since a low level of inflation has always led to a stable economy. However, if reflation leads to high inflation (above 2%) then it is considered destructive to the general economy, and our Federal Reserve usually steps in to extinguish inflationary pressures. Except this time the Fed may not be able to combat inflation. (If it fights inflation then it causes growth to further stagnate; if the government encourages economic growth it sparks rising inflation).
Inflation is usually driven by strong economic growth. As we discussed before, it is unlikely that we will experience a high growth rate for quite a few years. But inflation can occur during periods of stagnant growth if there are constraints on supplies. We are facing numerous future constraints. Our growing trade deficit, aging population, rising cost of labor around the world, and supply-constrained commodities are all contributors to inflation. Inflation with stagnant growth is called stagflation and it looks like this is where we are heading in the long run (probably a year from now). Stagflation requires a completely different investment mindset. For instance, in a world prone to inflation and slow growth, fixed rate securities like Treasuries are really not “risk free” or safe since a rising inflation rate can eat up the wipe out any real return.
Since the early 1980’s inflation, also known as the Consumer Price Index or CPI, has been steadily falling in virtually every economy from double digits down to 2% (see chart below). So inflation has not been a factor on which investors have had to focus. As inflationary pressures reappear, it will become important to reach back to the investment strategies that worked thirty years ago and update them to meet the changing securities markets. For instance, strategies that emphasize inflation-linked bonds and commodities will probably do well in this environment while stocks may under perform.
In the near term, we will be experiencing reflationary pressures coupled with a stagnant or low growth economy. In this environment, high quality corporate bonds and municipal bonds will perform the best when mixed with stocks and the slow introduction of inflation-linked securities. Commodities in the near term will not perform well but will shine when inflation takes off. Your portfolio rebalancing recommendations will reflect the realities of this new investment landscape. Please review your rebalancing recommendations and return them to us as soon as possible.
The new administration certainly has an amazing number of wild fires to deal with. It will be impossible for them to put them all out and put things to right quickly. It will take massive government intervention in the form of both tax cuts and spending on infrastructure to stop the consequences of the sudden de-leveraging of financial markets, consumers and businesses. This will be a protracted recovery. Over the last few weeks the credit markets have begun to thaw. High quality corporate and municipal bonds will recover first as yield spreads to Treasuries narrow. The stock market will hold steady and may begin to slowly recover in late 2009 but will face massive head winds in the near term.
It is important to adjust to the economic headwinds we face and shift your portfolio to reap any strategic advantage the markets offer. The markets always recover in the long term but each time it is different. The key is not to panic. Instead, focus on identifying these differences and shift your portfolio to take advantage of them. Hiding in Treasuries will not repair your portfolio but may in fact garner you further losses. Short term volatility always yields opportunities if you know where to look.
Inflation is usually driven by strong economic growth. As we discussed before, it is unlikely that we will experience a high growth rate for quite a few years. But inflation can occur during periods of stagnant growth if there are constraints on supplies. We are facing numerous future constraints. Our growing trade deficit, aging population, rising cost of labor around the world, and supply-constrained commodities are all contributors to inflation. Inflation with stagnant growth is called stagflation and it looks like this is where we are heading in the long run (probably a year from now). Stagflation requires a completely different investment mindset. For instance, in a world prone to inflation and slow growth, fixed rate securities like Treasuries are really not “risk free” or safe since a rising inflation rate can eat up the wipe out any real return.
Since the early 1980’s inflation, also known as the Consumer Price Index or CPI, has been steadily falling in virtually every economy from double digits down to 2% (see chart below). So inflation has not been a factor on which investors have had to focus. As inflationary pressures reappear, it will become important to reach back to the investment strategies that worked thirty years ago and update them to meet the changing securities markets. For instance, strategies that emphasize inflation-linked bonds and commodities will probably do well in this environment while stocks may under perform.
In the near term, we will be experiencing reflationary pressures coupled with a stagnant or low growth economy. In this environment, high quality corporate bonds and municipal bonds will perform the best when mixed with stocks and the slow introduction of inflation-linked securities. Commodities in the near term will not perform well but will shine when inflation takes off. Your portfolio rebalancing recommendations will reflect the realities of this new investment landscape. Please review your rebalancing recommendations and return them to us as soon as possible.
The new administration certainly has an amazing number of wild fires to deal with. It will be impossible for them to put them all out and put things to right quickly. It will take massive government intervention in the form of both tax cuts and spending on infrastructure to stop the consequences of the sudden de-leveraging of financial markets, consumers and businesses. This will be a protracted recovery. Over the last few weeks the credit markets have begun to thaw. High quality corporate and municipal bonds will recover first as yield spreads to Treasuries narrow. The stock market will hold steady and may begin to slowly recover in late 2009 but will face massive head winds in the near term.
It is important to adjust to the economic headwinds we face and shift your portfolio to reap any strategic advantage the markets offer. The markets always recover in the long term but each time it is different. The key is not to panic. Instead, focus on identifying these differences and shift your portfolio to take advantage of them. Hiding in Treasuries will not repair your portfolio but may in fact garner you further losses. Short term volatility always yields opportunities if you know where to look.
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