How To Profit From Deflation

A sharp decline in stock prices has stunned investors in the first weeks of 2016. This rapid decline follows a prolonged and deep decline in commodity prices.

Monetary authorities across the globe are increasingly concerned that headline inflation is close to zero and drifting lower. It appears that we may be in for a bout of deflation, especially if global economies turn down again.

If that happens, income investors will have only one safe haven: prime corporate bonds.

Deflation, Dead Ahead

The glut of money in the economy is one of the primary causes of this deflation, both in the United States and worldwide.

Until about 2012, the Fed’s monetary “stimulus” worked the way we thought it should: The output of goods and services rose and inflation also began to trend upward, as gold and commodities prices headed for the heavens.

Then, in 2012, everything went into reverse. Inflation stopped rising and began to decline, while gold and commodity prices went into a steep decline. Oil prices joined them after mid-2014.

Now, overall consumer price rises are close to zero, even though the U.S. “core” consumer price index is being artificially propped up by the “owner’s equivalent rent” sector, a fudge factor invented by the Bureau of Labor Statistics that accounts for 40% of the core index – which is up over 3% in the last year.

Economically, you’d expect this. The Fed, through its monetary policy, has caused the economy to produce more goods and services than it otherwise would. Logically, that should cause the price of goods and services to decline.

The biggest declines should be in areas where a lot of capital is needed. Energy and mining both require huge capital investments up front, so ultra-low interest rates and high energy and commodity prices have produced a huge glut.

You’d expect real estate to be in oversupply, too. Chinese real estate certainly is, and the world hotel industry seems to be heavily overbuilt. U.S. housing is probably in less oversupply, because homebuilders are still recovering from their 2008-10 near-death experience.