Judging by the inflows into TIPS exchange traded funds (ETFs), investors are worried about the prospect of inflation. But the real concern these days might be deflation.
Economists and other analysts caution that the United States may soon be caught in a deflationary trap similar to what Japan experienced in its lost decade, reports Don Lee for The Los Angeles Times. Deflation is ugly: prices drop, lower prices reduce business profits, managers cut back on employees, consumers buy less and lower demand brings in another round of lower prices. Exacerbating the situation, frugal consumers often wait for prices to decline even more. [ETF Strategies to Cope With Deflation.]
The Inflation index in June inched up about 1.1% year-over-year. The core inflation rate, which excludes volatile energy and food items, has plummeted to a 44-year low of 0.9%. In comparison, the Federal Reserve has a target inflation rate of 1.5% to 2%. The Fed projects core inflation will linger at current levels then rise to 1.5% by 2012.
The Fed’s Chief, Ben Bernanke, however, believes that deflationary fears have been blown out of proportion.
Market analyst Robert Prechter isn’t so sure, though, writes Roshawn Watson for Watson Inc. Prechter feels that stocks are overvalued, raising the likelihood of a deflationary period.
What can you do?
The greatest asset to own during a deflationary period would be cash since anyone with cash on hand would preserve his or her purchasing power as other asset classes plummet. Other assets that may fare decently in deflationary times include:
- Short-term government bonds.
- Short ETFs – but use caution. These are not meant for buy-and-hold and must be used with care and understanding.
- Dividend ETFs.
For more information on inflation, visit our inflation category.
Max Chen contributed to this article.