johnnymk

http://online.wsj.com/article/SB123827800749765963.html

By GREGORY ZUCKERMAN
Will it be inflation or deflation?

As economies around the globe weaken and stock markets try their best to stage a recovery, some experts worry about the risk of deflation, an extended period of falling prices. That's something usually seen in deeply troubled times, such as the Great Depression.

But another camp is just as concerned about the exact opposite scenario: rapidly rising prices, or inflation, caused by the concerted efforts of central banks and governments around the world to shovel money at the growing problem areas.

For investors deciding how to adjust an investment portfolio for both the short term and long term, the debate is both crucial and confusing, especially since the end result actually might be some combination of the two.

"We believe it's quite possible to have commodity-price inflation at the same time you have broad-based deflation," says Jason Trennert, chief investment strategist and managing partner at Strategas Research Partners. Others believe a period of falling prices could be followed by one of inflation.

Consider Commodities
Some investments, such as U.S. Treasury bonds, look attractive if deflation occurs, but could get clobbered if inflation picks up. Gold and other precious metals could do well in either environment, some investors and strategists say. Commodities could be winners if inflation ignites, along with inflation-indexed bonds.

Individuals should have exposure to all these holdings in a diversified portfolio. Some pros say investors should be prepared to shift more toward inflation protection over the next year or two, but don't need to make wholesale changes now as the outlook remains in flux.

Certainly, higher inflation isn't much of a worry lately. The consumer-price index climbed just 0.2% in the year through February. Though energy prices are edging higher, there's no sign of a resurgence in overall inflation, as most industries find it difficult to raise prices. It's not just in the U.S., either. The rate of inflation in the euro zone is expected to hit zero this year.


If economic activity remains weak, some say deflation is a possibility, as companies compete to lower prices to attract customers. A. Gary Shilling, a bearish economist, forecasts annual deflation of about 2% over the next few years, as consumers save more and the "overall supply of goods and services exceeds demand."

Bonds, which provide a steady stream of interest payments, are attractive in a deflationary environment. If prices fall, that interest income will buy more goods and services in years to come. Treasurys and the safest corporate bonds could remain attractive until it's clear that deflation is no longer a possibility, analysts say.

Gold-related investments also could do well in such a deflationary environment -- the yellow metal usually does a good job storing value in difficult times, and would be seen as a better alternative to stocks.

The Fed Goes Shopping
But the Federal Reserve recently launched a plan to buy a massive amount of debt securities in an effort to push down loan rates for businesses and consumers. And it's committed to buy more, if necessary. That could help prevent a bout of scary deflation, and even lay the groundwork for rising prices. Here's the logic: When governments print money and spend like there's no tomorrow, more cash chases the same number of products, leading to higher prices eventually.

A return of unhealthy inflation is no sure thing, of course. Just as the Fed slashed rates it also could raise them if needed to curb inflation. And it won't become a problem until consumers begin spending and banks lend again.

Still, a growing number of analysts say investors should begin to slowly rework their portfolios over the next year or so to prepare for a possible rise in inflation. Stocks generally do better than bonds when inflation rises, but unless an investor is convinced that the economy is close to bottoming, it may be too early to plow into equities.

Oil, gold, copper and other hard assets become more valuable as prices rise, so commodities and commodity-related shares could become winners if inflation perks up. And if confidence in global currencies falters, as the central banks put their printing presses on overdrive, more investors may turn to gold, which has served as a quasi-currency for thousands of years.

Individuals can get commodities and gold exposure through exchange-traded funds such as PowerShares DB Commodity Index Tracking Fund and SPDR Gold Trust .

In a recently published interview with a J.P. Morgan Chase banker, John Paulson, the hedge-fund manager who anticipated the collapses of the subprime mortgage market and financial companies, said mining stocks also look attractive. "I expect inflation to increase, which should benefit real assets," Mr. Paulson said. "From a long-term perspective, natural-resources stocks also represent good buying opportunities."

Time for TIPS
Treasury inflation-protected securities, or TIPS, are another obvious antidote to rising prices. The value of these bonds rises along with inflation as their principal is readjusted to compensate for the rising prices. It helps that the Fed has said it may buy TIPS, along with conventional Treasurys.

"Right now TIPS are not priced for acceleration in inflationary pressure and are therefore attractively priced for investors who are concerned about inflation," says David Joy, chief markets strategist at RiverSource Investments.

The most likely scenario could be a pickup in prices of energy and food but limited inflation elsewhere, as the economy tries to right itself.

zippyjuan

I don't think we will see much inflation for at least a little while. Or deflation. Energy costs have stablized meaning that the negative effect of soaring prices last year and their falling back down in recent months are no longer having an impact (positive or negative) on the costs of producing or distributing goods. We did see deflation in the second half of 2008 for two reasons- first the falling energy prices noted here and secondly because companies found themselves with too many goods during the critical holiday shopping season so they slashed prices to try to move them. Since then, they have adjusted their production to lower levels- both at the wholesale and retail levels. This will ease their need to cut prices even lower. They have reduced their labor costs by reducing their workforces too (via layoffs or merely reducing hours for workers).

The large amounts of money which the Fed and the government have been trying to pump into the economy can have inflationary impacts- more money demanding a supply of goods which is not increasing as fast as the money supply. But one thing has to happen which is not occuring currently. That is that this money has to be lent out and used to buy stuff- whether that is a factory buying new equipment or people buying frozen pizza at the grocery store. Businesses and consumers both seem to be retrenching- cutting back on borrowing and spending. That means that all the stimulus is not doing much stimulating.

If people do start borrowing and spending again then we could see some prices ticking up. First will be because the demand could quickly get larger than the reduced supply of goods meaning shortages of some things. Secondly, companies have greatly cut their margins on goods and would like to regain some of that back when they can. I predict that towards the end of the year we will see some increase in demand for things and fewer holiday price reductions. Perhaps some incrase in inflation by that time. I think the deflationary period is already over but don't yet see any major spike in inflation yet either.

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renovation

this the first quarter of the year is hard to get a true feel. becouse tax refunds are being reinvested back in to the economy. the reports afterthe monthof May tell the truth though December. hell i of one chick who help the economy this weekend. she went and had a boob job with her tax refund

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