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What works in deflation or mild deflation?


Vish_ram
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I'm totally intrigued by fairfax's derivative position that is betting on deflation (I didnt see any discussions on this).

 

Given Japan's experience with long term deflation, I would be interested in getting some feedback on what sectors, industries or stocks work well in deflation.

 

It is obvious that Real estate is a bad place to be.

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Interestingly, Ian Gordon (LongWave group) has argued that we are in the 'winter' phase of the Kondratieff cycle.

He expects much of the debt at all levels not to be repaid, serious economic contraction, and general decline in most prices (except gold/silver).

Defletation actually happened in the early 30s in the US

 

His advide:

gold bullion

gold junior miners (leverage to gold)

shorting selective stock indices

 

 

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It is obvious that real estate is a bad place to be? On what  basis do you make that observation? Is it because of a prediction of declining rents or declining asset prices clearly the two are linked but I presume the asset prices follow the rents as opposed  to the reverse.

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Interestingly, Ian Gordon (LongWave group) has argued that we are in the 'winter' phase of the Kondratieff cycle.

 

His price target is DOW 1,000 -- in other words, the DOW will fall 92%.

 

So let's just look at some DOW components:

 

MSFT:  will fall to $16b market cap?  Wow, net-net.  Who would have imagined that?

 

This guy is truly visionary.

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1930s were deflationary. 

 

ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt

 

We start out with deflation even BEFORE the 1929 crash -- so it isn't like a huge new trend that suddenly happened with the crash, rather it was a magnification of that trend:

 

1927  -1.7% CPI

1928  -1.7% CPI

1929  0% CPI

 

Deflation accelerates with widespread panic -- no doubt the cascading bank failures had something to do with this (no FDIC protection either)

1930  -2.3% CPI

1931  -9.0% CPI

1932  -9.9% CPI

1933  -5.1% CPI

 

Then, after that period is over, what happens for the rest of the decade?

 

1934  +3.1% CPI

1935  +2.2% CPI

1936  +1.5% CPI

1937  +3.6% CPI

1938  -2.1% CPI

1939  -1.4% CPI

1940  +0.7% CPI

 

Is it presently the beginning of 1930 and we're about to see 9+% deflation over the next two years?  Or is it the end of 1933 and we're going to see inflation for the next 4 years, followed by two mild years of deflation and then followed by another decade of inflation?

 

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cash

If you do think things may implode (including banking stability), where exactly do you store your cash?  Are you safer holding shares of a strong company with no debt?

 

Does deflation (or mild deflation) and another systemic banking crisis necessarily go hand in hand?

 

Of course, Vish_ram was specifically asking about sectors, industries or stocks that do well during deflation, so I'm guessing the "cash" response was a bit tongue in cheek!

 

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It is obvious that real estate is a bad place to be? On what  basis do you make that observation? Is it because of a prediction of declining rents or declining asset prices clearly the two are linked but I presume the asset prices follow the rents as opposed  to the reverse.

 

For real estate, the twin effects of reducing home prices and rents can wreak havoc on prices. In places of high inflation, the pitiful rent is always overcome by rising home prices (india), in mild to moderate inflation, if home owners have fixed mortage payments, any nominal increase in home prices accrues to the home owner (transfer of wealth from bond holders to home owners).

 

There was another post that said, the real return on housing is practically zero. that means given some inflation ,what ever home price appreciation we got is purely in nominal terms. Now if you are going to have deflation, home prices are sure to drop even more.

 

The actions of treasury and Fed reminds me of the lead character in "around the world in 80 days", burning pieces of furniture and other wooden parts in the ship to keep it going. how long is it going to last? the wood being the credibility of the US$. What if structural unemployment rate is 10% in US?

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There was another post that said, the real return on housing is practically zero. that means given some inflation ,what ever home price appreciation we got is purely in nominal terms. Now if you are going to have deflation, home prices are sure to drop even more.

 

 

You are ignoring the value of the cash flow.  I guess a utility yielding 14% is not worth purchasing if the price gains are merely nominal?  I mean, that's really the issue here.  You are asserting that real estate is poor investment but not discussing the fundamentals.  Just speculating on price movement.

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I don't think history is a very good guide sadly.  Reason being that past bouts of deflation have been for different reasons than what we see today.

 

1930s deflation was largely demand driven and brought about by currencies tied to gold, trade imbalances between the US and Europe, and lastly significant deleveraging.

 

In the 1870s-1880s there was another persistent bout of deflation, but that deflation was brought about by excess supply (large agriculture surpluses in the US and Argentina).  And by better transportation (railroad and canals) that made costs for shipping commodities cheaper.

 

Flash forward to now, we have some of the economic conditions of the 1930s, but we are a net importer and are no longer tied to gold.  Still we are experiencing significant deleveraging.  However, on the commodity side, BRIC monetary easing and loose credit has caused overall demand for commodities to rise and prices have responded.  If BRIC central banks continue to tighten and fight inflation, perhaps the commodity demand will abate.  But over the longer term I think the Grantham argument of increased demand through rising incomes means more shortages and surpluses.

 

For these reasons, I don't think that traditional defenses against deflation are all that good.  Perhaps the best move would be to hold BRIC currencies or local currency denominated short term debt like in PLMDX.

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There was another post that said, the real return on housing is practically zero. that means given some inflation ,what ever home price appreciation we got is purely in nominal terms. Now if you are going to have deflation, home prices are sure to drop even more.

 

 

You are ignoring the value of the cash flow.  I guess a utility yielding 14% is not worth purchasing if the price gains are merely nominal?  I mean, that's really the issue here.  You are asserting that real estate is poor investment but not discussing the fundamentals.  Just speculating on price movement.

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There was another post that said, the real return on housing is practically zero. that means given some inflation ,what ever home price appreciation we got is purely in nominal terms. Now if you are going to have deflation, home prices are sure to drop even more.

 

 

You are ignoring the value of the cash flow.  I guess a utility yielding 14% is not worth purchasing if the price gains are merely nominal?  I mean, that's really the issue here.  You are asserting that real estate is poor investment but not discussing the fundamentals.  Just speculating on price movement.

Sorry for the fat fingers again. The observation about real estate being a poor investment does have to be based upon falling rents or else we ain't value investors we are just price speculators and Mr. Dodd and Buffett have been wasting a lot of breath. I am as nervous as a long tailed cat in a room full of rocking chairs right now about the valuation of a lot of equity investments at this stage and I have been trying to hedge my 50 percent equity exposure (the rest is cash) with a volatility bet. But a foreclosed house purchased @ 50% of replacement cost and a good long term tennant looks like as safe a bet as one can make right now. I think what you find in depressions, residential rents are pretty sticky people finding difficulty in paying the rent get room mates. NOBODY is building any new housing of any consequence and millions of more families are about to get foreclosed  many will have to become renters.
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NOBODY is building any new housing of any consequence and millions of more families are about to get foreclosed  many will have to become renters.

 

The moment that happens they'll just rent the unit that is being sold.

 

These rents are far lower than the mortgage they were trying to pay.

 

Surprises me that people aren't noticing that foreclosures simply mean people with extra money to spend on consumption.  Except for the squatters that got 18+ months of sitting in the home without making payments of course.  But generally speaking, the rents are nowhere near the 2006 level of mortgage payments.

 

It seems to me like the prior rent level must have been artificially low, due to the oversupply of housing during the construction boom (people who should have remained renters bought new homes, artificially depressing rents).  Now the opposite situation over the next few years if construction remains depressed -- a housing shorting, artificially boosting rents. 

 

Of course, people argued that over supply was the main impetus behind the housing collapse, but refuse to accept that a supply shortage is looming.  They want to instead point out that Japan house prices just kept going lower, despite their population of home dwellers doing the same (which doesn't seem to matter to these bears, for whatever reason supply/demand isn't in vogue).

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Is it presently the beginning of 1930 and we're about to see 9+% deflation over the next two years?  Or is it the end of 1933 and we're going to see inflation for the next 4 years, followed by two mild years of deflation and then followed by another decade of inflation?

 

If you look at the level of debt in the private sector there should be more de-leveraging to go (at least for a few more years). If the government goes for austerity then there could be a wave of deflation. Wouldn't you agree?

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What's going to work in deflation or mild deflation:

 

I am going to guess - dividend paying companies that we(consumers) can t do without-utilities, telecom, cable cos, healthcare related-drugs.

 

Bonds are suppose to do well in this scenerio but it seems that this is currently priced into the price of bonds.

 

Cash is a good idea

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Is it presently the beginning of 1930 and we're about to see 9+% deflation over the next two years?  Or is it the end of 1933 and we're going to see inflation for the next 4 years, followed by two mild years of deflation and then followed by another decade of inflation?

 

If you look at the level of debt in the private sector there should be more de-leveraging to go (at least for a few more years). If the government goes for austerity then there could be a wave of deflation. Wouldn't you agree?

 

Anything is possible.  However I'm wondering about that idea of looking at debt in the private sector.

 

If I have $300,000 of mortgage debt and my house is underwater by $100,000... and I walk away from the house, isn't that delevering?  I can still go out and spend like I always did... nay, I can spend more because renting is cheaper..

 

And supposing the MBS that carries my mortgage is already discounted in the market place by that $100,000... then what happens to the economy?  I walk away and the value of the MBS doesn't change, but now I spend more?

 

I realize that this doesn't explain the entire picture, I'm just wondering if we've already deleveraged at least a good portion of that consumer debt... this due to so many of them trading in the marketplace in these bundled securities, and at least substantially discounted by the market.

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I'm totally intrigued by fairfax's derivative position that is betting on deflation (I didnt see any discussions on this).

 

Given Japan's experience with long term deflation, I would be interested in getting some feedback on what sectors, industries or stocks work well in deflation.

 

It is obvious that Real estate is a bad place to be.

 

Ok, I'll bite... How about FFH? It will give you instant exposure to Fairfax's derivative position!

 

I'm somewhat serious though. If you truly believe deflation is coming, buy FFH and close your eyes for the ride. They're positioned to do pretty well in that scenario.

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I realize that this doesn't explain the entire picture, I'm just wondering if we've already deleveraged at least a good portion of that consumer debt... this due to so many of them trading in the marketplace in these bundled securities, and at least substantially discounted by the market.

 

That's why I talk of "only" a few more years. Levels of debt seem still pretty high to think that a bit more is in the card at least. If I look at the people I know, hals of the ones that were in trouble when the shit hit the fan are still in deep doodoo!

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"Levels of debt seem still pretty high to think that a bit more is in the card at least"

 

There's nothing like inflation to melt away debt and make debt ratios look miniscule. Suppose I have $100 debt and $200 of hard assets, my debt to asset ratio is 50%. But now inflation kicks in and my hard assets are worth $400 but my debt is still $100 , my debt to asset ratio is 25%. There is no such thing as too much debt in an inflationary campaign, it all goes away like magic!

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