How To Protect Your Portfolio During Deflation By Chuck Clark The Clark Financial Group, LLC www.ClarkFinancial.com
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How Can You Protect Your Portfolio During Deflation? There are many economists who believe, and for good reason, that the United States is heading towards a serious deflationary period. Obviously, there's no way to know for sure that this will happen, but it definitely makes sense to prepare yourself and be ready to protect you investment portfolio, if it does. For successful deflation investing strategies, we should look toward Japan to see what has worked there for the last 20 years. In the late 1980’s Japan’s stock market and real estate bubbles burst. After their bubbles popped, the Nikkei 225 average lost two thirds of its value, and Japanese 10-year treasury yields fell all the way to only 1%. The economic damage was so severe that 20 years later, their stock market has still not recovered. This real world example can be used for ideas in the U.S. today.
So, how do you protect your portfolio, and even find ways to profit during deflation? First of all, cash is king. In a deflationary period, the Dollar will rise in value. There are several ways to take advantage of this, depending upon your risk tolerance. If you’re ultra conservative, you need to keep your money in cash and cash equivalents, such as interest bearing savings and checking accounts, money markets, and CDs. You need to understand that if you choose this route, you will receive almost no interest at all. While your yields may be paltry, your principal will be safe.
If you’re looking for higher returns and are willing to accept some risk, there is a bullish dollar ETF called the PowerShares DB US Dollar Index Bullish Fund, which has a trading symbol of UUP. The fund is designed to replicate the performance of being long the US Dollar against a basket of foreign currencies. For very aggressive traders, you can take long positions in the Dollar on the Forex. This strategy can yield the most profits, but can also create heavy losses. This strategy is definitely not for the faint of heart. In regards to the bond market, US Treasuries will offer safety, and a bit more yield than cash equivalents, but can burn you towards the end of the deflation cycle. As the economy cycles out of the deflationary period, interest rates will start to rise in an effort to stave off inflation. As interest rates go up, the principal value of your bonds will go down.
What about stocks? You can make money in certain stocks and certain sectors, even in a deflationary period, but you need to be very selective. Sticking with the theme of cash is king, you should look for companies that have: • • • • •
A Strong balance sheet High levels of cash on hand Solid cash flow A history of consistent dividend payments Pricing safety
If you’re looking at the above criteria and thinking about utility stocks, you’re right on the money. Rather than buying an ETF that mirrors an index, we would recommend that you selectively invest in individual companies within the industry. You will also find individual names within other industries that meet the criteria.
Another good strategy for stock investing is to invest in foreign stocks from countries that aren’t experiencing deflation. We would expect China, as well as many emerging market economies to remain strong, even if the United States is experiencing heavy deflation.
What about gold and other precious metals? While the common theory is that gold is the perfect hedge for a bad economy, history has actually proven that’s not necessarily the case. Robert Prechter from Elliott Wave International explains this in more detail in this article: Economic Hedge The bottom line is there are safe harbors and opportunities to profit, even during difficult economic times. You just need to change your traditional investing methodology to one that is suited better for deflation investing. To learn more trading strategies, visit: Online Trading