March 2015 Index
April 2, 2015
Inflation – Deflation Battle Rages
Our regular readers know that we have been vigilant for signs of rising inflation for the past few years. While it has shown up in certain countries, or appeared in specific markets for short periods of time, it has definitely not been persistent. On the contrary, deflationary pressures have been the bigger problem, and now seem to be spreading from the over-levered, slow-growing developed economies to global commodity, currency, and bond markets.
Central Banks Continue To Press the Fight
As we have written many times in these letters, central banks and policy makers have launched massive fiscal and monetary stimulus programs to spur economic demand since the financial and banking crisis of 2008.
The U.S., Japan, and the UK have provided the global economy with several trillions of dollars of quantitative easing (QE). Last month, the European Central Bank launched their own massive QE program, committing to “print” nearly a trillion Euros over the next 18 months and perhaps longer. In spite of all of these efforts, central bankers’ inflation goals or targets are not close to being achieved.
Global Demand For Goods Is Slowing, So Countries Want To Lower Their Currency To Spur Foreign Demand For Their Goods
Currency devaluations are the prescription being applied for what ails Europe and Japan. In theory, it will create demand for their export goods and spur some inflation due to the rising prices of imported goods. There is a problem with the theory: other countries are trying to do the same. Weakening growth and deflationary pressures are not confined to mature, developed economies. Emerging economies are seeing falling inflation rates. The Bank of China this past weekend warned that they too see deflation and weakening growth, and plan to use whatever tools they have to fight it. Meanwhile many other emerging economies that have been dependent on commodity exports for growth are also trying to devalue.
Longer term, prices will respond to the upside
For the time being, prices of many raw materials and finished goods are not rising. Supply gluts in energy markets, a series of bumper crops in agriculture, and improved manufacturing efficiencies are conspiring with sluggish global demand to keep a lid on prices. Our Guild Basic Needs Index (GBNI), which we track here, tracks certain components that make up basic, essential needs (food, clothing, shelter, and energy). In 2014, the GBNI declined 10 percent.
What Does This Mean For Investors?
The deflation/inflation battle makes for choppy investment markets. All of the global stimulus is good for asset prices, but the sluggish demand can hurt corporate earnings. In 2014, a lot of investment markets around the world suffered big declines in U.S. Dollar terms as currency values fell. So far in 2015, we have seen a lot of Yo-Yo action in U.S. bonds and stocks. January was dominated by deflation fears. U.S. stocks sagged on fears of lower earnings due to the strong Dollar, and so bonds rallied. Then, in February, stocks bounced and bonds retreated. Then in March, both reversed… again.
Volatility for U.S. Stocks…
…and U.S. Bonds
Investment implications: Expect choppy markets until investors get more clarity on the inflation picture and how fast interest rates will rise… or whether deflation and zero to negative interest rates will dominate. In this environment, the better opportunities may be found overseas in countries that have lagged for the past few years, and who are aggressively stimulating their economies. Just make sure you hedge the currency risk.