The rally has been over for a good two months, and the markets have been stuck in a trading range since the New Year. Recent concerns over the potential of sovereign debt crises, however, show that we’re not out of the woods yet.
Just consider some of the following areas for potential setbacks in the markets: unemployment numbers in the U.S. remain at an average of 10% with no immediate signs of possible improvement in the short-term. Moreover, there is little inflation pressure on the economy despite the excess liquidity nominally in the system. As a result, the Fed funds rate is presumed to remain at extreme lows at least through the second and third quarter of this year.
Meanwhile, prices have been continuing to decline on the supply of unsold homes, an overall number of which grew in January to the lowest ever level for U.S. home sales on record. As for gasoline prices, these aren’t keeping up with the costs of refining. The U.S. consumer does not pay for $78 oil at the pumps – and as a result, oil refineries have been shutting down – some say, permanently. Sunoco shut down in New Jersey and Shell shut down a refinery in Montreal over the past month or so.
Remaining Problems That Could Cause a Second Market Crash in 2010-2011
How to Profit From Deflation
So in the short term, we’re still looking at deflation for all effective purposes. Deflation refers to an economy in which prices fall over time. Strictly speaking, this is supposed to be the effect of deflation, but let’s just let that one go here. The fact is that prices on major items such as gasoline and home sales are continuing to decline or at least not experiencing upward pressure.
So what is good to invest in for a deflationary economy? What should you be doing with your money if interest rates are going to remain low for another year?
1. Earn more money. Interestingly, earning more money will benefit you whether we’re in a deflationary or an inflationary environment. If it’s inflation, you’ll be required to earn more anyway. For deflation, you’ll see some benefit since you’ll actually be able to get ahead of prices.
2. Lock in low rates. Take advantage of cheap money while it lasts. Banks aren’t paying to borrow money right now, and variable rates will be trailing low. This can make it easier to pay off your debt or mortgage if you can put less towards interest and more towards your principal.
When Will the Fed Raise Rates? A Few Estimates
3. Take advantage of sales. If you need to buy a new home, you might be able to find one now at the bottom of the market. Times are tough, but potentially near-perfect for first-time home buyers willing to be flexible with location.
4. Take advantage of stimulus measures. Home improvement credits, first-time home buyer tax credits, and other stimulus packages are all signs of a deflationary economy. The government wants spending to pick up and this is one way it attempts to do that.
5. Buy stocks that aren’t affected by deflationary movements in consumer prices. Utilities and telecommunications companies do well because they generally don’t reduce their prices, or don’t need to, in economic slumps. Many of these companies continued to raise their dividends throughout the 2008-2009 financial crisis. Tech stocks, however, may not do as well if they are too affected by retail price fluctuations of electronics and computer items.
The markets are built for inflation, so it’s naturally easier to make money, and think about how to make money, in an inflationary environment. What we’re seeing now is an absence of much inflationary pressure. There is not wild and massive deflation around us – so you may not notice much of a difference. If it gets considerably worse – more prolonged or pronounced – then we might start to see more deflation in everyday goods. So if you keep track of your regularly shopped items, you could also stock up on your needs when the prices get cheap.
Other than that, just make sure you consider curbing back a bit on your inflation investing strategies.
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{ 4 comments }
I think you’re right on the money with your recommendations. This is no time for speculative moves. We may not be able to make money in this environment, but there’s so much pre-positioning that can be done if we understand the dynamics at work.
Also, while we may be in a relative deflation at the moment, there’s so much going on in the background–continuously at that–that we need to be prepared for sudden shifts. We’re in an environment where quite literally anything can happen. We still have no idea how the European situation will play out with Greece or whether it will spread to other countries. And that’s just one of the variables.
Yes, there’s always a lot of variables in the background, but it seems that now we’re more aware of how they may all be interconnected and dependent on each other as parts of a complex (unpredictable) system. Why stable dividend stocks are also becoming more attractive.
We actually invested a little extra in our retirement accounts during the recent recession, since we can get more for less, and that will be a big help later on down the road. I also really like your suggestion to pay off debt quickly. Now’s a good time since more will go to principal.
@Miranda – yep, in alot of cases, it could become a larger return than you would get putting the same amount of money into an investment. Effectively, you’d save yourself the interest you’d have to have paid, and in that sense you pay less for debt reduction (i.e., it’s a return because your absolute wealth moves higher up on the real number scale).
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