Half the experts in the USA are worried about deflation, wanting the U.S. Govt to pump more money to increase purchasing power of the American popluation. Half the experts warn that (a) Enormous budget deficits, (b) low growth rate, (c) poor savings rates (d) record sums of money put in the economy over last 2 years have almost guaranteed hyperinflation.
Now, we do not know what the future holds. If we have deflation, then the value of money should increase. Money in the bank will become more vaulable while asets will become less valuable. But, there is one point to remember: modern gobernments have many ways to try and stimulate demand, therefore, deflation i a worry but not a catastrophe.
What about runaway inflation? In October 2009, food inflation in India was about 14% and we had repeated assurances by Prime Minister Dr Manmohan Singh that food prices will come down over the enxt few months. Instead, ten months later,in July 2010, food inflation continues at 12.4%. Again, the PM has assured citizens that inflation will come down in the next few months!
My point is: For any govt, the control of inflation is difficult, if not impossible. Therefore, as traders, we should plan for an inflationary environment, which if it come about, will persist for a long time.
Marc Faber suggests that hyperinflation is coming. He also suggests that stocks will outperform bonds (bank deposits for us). This view seems fair since assets suddenly start increasing in value in times of inflation.
For investors, the problem is elsewhere. A lot of stocks are clearly overvalued, even now. While they may well be trading candidates, putting our hard earned money in such stocks carries increased risk of loss of capital.
This is what I am working on, for my investment portfolio.
Some small cap and mid cap stocks continue to have value. Which mean they are available at low valuations, and, they make money. The list is small, but it is there. When we invest in small caps with value, this is what happens (all references to small caps mean small and mid caps that have value):
In times of momentum driven rallies, small caps underperform momentum stocks by a wide margin. Nobody wants to buy value.
In times of declines, small caps fall less than the general market / momentum stocks. Volume is low since nobody wants to buy them in declines.
In times of steadily rising bull markets, small cap catch up eventually, outperforming momentum / growth stocks by a wide margin.
In inflation induces rallies, small caps should give outsized gains. But, such gains take time to mature.