Deflation/Inflation

[bargainman]

So we all know that there are smart people on both the inflation and deflation side of the debate/trade.  My question to those here is...  Being that I'm just a small investor and have no idea what the economy will do from a deflation inflation standpoint, what are some investments that will do well in *either* scenario??  Would love to hear anyone's ideas..

[merkhet]

I would think you'd want cash.

 

Inflation: (assuming something like '70s stagflation) stocks fall, you'll want dry powder

 

Deflation: (assuming something like '30s deflation) stocks fall, you'll want dry powder

[cwericb]

But by definition, wouldn't you expect the price of stocks rise to keep pace with inflation? And with the same thought, cash becomes devalued.

[rkbabang]

But by definition, wouldn't you expect the price of stocks rise to keep pace with inflation? And with the same thought, cash becomes devalued.

 

That is what I would think.  Deflation you would want cash to buy cheap.  Inflation you would want to be fully invested, because cash will loose value where caeteris paribus stocks should keep pace with inflation.

 

--Eric

 

[Guest Bronco]

Bargainman - I can hear Parsad already.  You want to buy good businesses that trade at a fair discount to their intrinsic value.

 

Buy Loews.  They will make money on inflation with their oil interests, nat gas interests, and drilling operations. 

 

They will make good money on their pipelines in either scenario.

 

If deflation kicks in, their bond portfolio in CNA should do well.

 

Plus they have the dry powder that others were speaking of ($4B in cash at the holding company level).

 

And, drumroll - they trade at a discount to IV.

 

Honestly though, I am switching to Berkshire Hathaway.  I think $82 is too cheap, and I just see $20B in earnings in the not too distant future.  But I still own a chunk of Loews.

 

I also think Apple is getting attractive again.  They will win in inflation or deflation because they have your dry powder and ridiculous FCF.

 

I like TAP in the low $40's.  They may do well b/c drinking may go up as people celebrate but also when they drown their sorrows.  Maybe MO for the same reason. 

 

 

[omagh]

Inflation affects cost inputs (raw materials, inventory, labor, financing, etc).  The cost of the inputs can only be passed along to customers at suboptimal rates, meaning that companies must absorb the input costs in their value chain.  Companies with pricing power have the ability to pass along most if not all costs to their customers.  Over time, most costs will be passed along, but margins of weaker companies will be destroyed in the process.

 

Quality of business is a critical stock selection factor (high margin, high ROE, demand stability across business cycles, etc).

 

-O

But by definition, wouldn't you expect the price of stocks rise to keep pace with inflation? And with the same thought, cash becomes devalued.

[rjstc]

A review of Buffetts 1980 Annual Shareholder Letter discusses the inflation portion. It doesn't look good. Unless they are in tax free accounts which gives a little help.

[merkhet]

 

But by definition, wouldn't you expect the price of stocks rise to keep pace with inflation? And with the same thought, cash becomes devalued.

 

 

That is what I would think.  Deflation you would want cash to buy cheap.  Inflation you would want to be fully invested, because cash will loose value where caeteris paribus stocks should keep pace with inflation.

 

--Eric

 

 

Check out Charlie Munger's performance during 1973 and 1974 the last time we had stagflation.  Presumably, he was invested in good businesses that were trading at a fair discount to their intrinsic value.  (After all, it is Charlie.)  However, that was no buffer for the concomitant drop in stock prices.

 

Now, if you mean inflation outside of the possibility of '70s stagflation, then you should be invested in companies that have pricing power commensurate or greater than inflation -- but I think we're not in a period of normal inflation.

[PlanMaestro]

Look for high dividend yields (or even better reestablishment of high dividends so you can buy them cheap) with pricing power. I have a distressed REIT that I think will do well in either scenario. I think banks would also do fine in a mild deflationary scenario, and would kill it in a recovery. Also, some exposure to emerging markets could help as a defense to a deflationary scenario.

[rjstc]

Results for Owners    BUFFETTS STATEMENTS

 

    Unfortunately, earnings reported in corporate financial

statements are no longer the dominant variable that determines

whether there are any real earnings for you, the owner.  For only

gains in purchasing power represent real earnings on investment. 

If you (a) forego ten hamburgers to purchase an investment; (b)

receive dividends which, after tax, buy two hamburgers; and ©

receive, upon sale of your holdings, after-tax proceeds that will

buy eight hamburgers, then (d) you have had no real income from

your investment, no matter how much it appreciated in dollars. 

You may feel richer, but you won’t eat richer.

 

    High rates of inflation create a tax on capital that makes

much corporate investment unwise - at least if measured by the

criterion of a positive real investment return to owners.  This

“hurdle rate” the return on equity that must be achieved by a

corporation in order to produce any real return for its

individual owners - has increased dramatically in recent years. 

The average tax-paying investor is now running up a down

escalator whose pace has accelerated to the point where his

upward progress is nil.

 

    For example, in a world of 12% inflation a business earning

20% on equity (which very few manage consistently to do) and

distributing it all to individuals in the 50% bracket is chewing

up their real capital, not enhancing it. (Half of the 20% will go

for income tax; the remaining 10% leaves the owners of the

business with only 98% of the purchasing power they possessed at

the start of the year - even though they have not spent a penny

of their “earnings”).  The investors in this bracket would

actually be better off with a combination of stable prices and

corporate earnings on equity capital of only a few per cent.

 

    Explicit income taxes alone, unaccompanied by any implicit

inflation tax, never can turn a positive corporate return into a

negative owner return. (Even if there were 90% personal income

tax rates on both dividends and capital gains, some real income

would be left for the owner at a zero inflation rate.) But the

inflation tax is not limited by reported income.  Inflation rates

not far from those recently experienced can turn the level of

positive returns achieved by a majority of corporations into

negative returns for all owners, including those not required to

pay explicit taxes. (For example, if inflation reached 16%,

owners of the 60% plus of corporate America earning less than

this rate of return would be realizing a negative real return -

even if income taxes on dividends and capital gains were

eliminated.)      BUFFETTS STATEMENTS

 

One question then is what rate eventually will inflation get to.  The major dip in most stock prices during the recession have eventually come back so between dividends and re-appreciation your maybe holding even. If (when) we get to high inflation it maybe doesn't look so good.  MY STATEMENTS

[Rabbitisrich]

I wonder whether inflation can improve the value of logistical and bargaining advantages. For example, MCD in China competes with delicious, dirt cheap food stalls because labor is cheap, and there are fewer health and realty code impediments to opening a small food stall. Land, labor, and food inflation plus gentrification may improve the power of economies of scale relative to idiosyncratic competitors.

[anders]

I believe the article 'How Inflation Swindles the Equity Investor' best describes what to do when it comes to inflation  :)

 

 

[ericd1]

Inverse long-term bond ETFs will do well as inflation heats up!  Then long-term bond funds will do well when rates decline.  Commodities will move up.

 

There will be some great buying opportunities.

 

 

[rjstc]

I believe the article 'How Inflation Swindles the Equity Investor' best describes what to do when it comes to inflation  :)

 

 

Thanks for this article. It was very good.