Deflation Investments to Consider with Inflation Fears Out the Window

by ETF Base on May 18, 2010

Deflation Investments are getting a lot of press this week.  Many experts are now shifting their sites from fears over inflation to a deflationary environment.  While the rampant printing of money and devaluation of currencies had been front and center since the financial crisis, there are now indications that we may be entering a period of sustained deflation both in the US and around the globe.  Naturally, the question is what some good deflation investments would be.  Deflation is generally considered to be an environment of slow economic growth and where there is actually a negative inflation rate, with the end result being an actual increase in the real value of money.  As unfathomable as it seems, it is a real scenario many economists are bracing for.  While the US hasn’t seen a classic case of deflation since the 1800s, other developed markets like Japan and Ireland have in the past few decades.

Some signs pointing toward deflation in the future include today’s Producer Price Report showing a decline and other indications that the economic recovery is slowing like a drop in new building permits.  Lest we not forget that Strategic Defaults are Growing as they’ve become the New Black.  This comes at a time when the Fed is withdrawing from market activities and the dollar is rising against major currencies.

Deflation Investing

Contrary to the concerns over income investments declining in an inflationary environment when inflation erodes the return of income instruments, in a deflationary environment, income investments actually look more attractive.

High Quality Dividend Paying Stocks

With the prospect of sustained or growing dividend payouts from stable blue-chip companies, high quality dividend stocks would continue to fare well, as they have during the month of May.

Some Reasonable ETFs offering High Quality Dividend Payers Include:

SPDR S&P Dividend Fund (SDY) – This ETF seeks to mimic the S&P High Yield Dividend Aristocrats Index and only the 50 highest yielders are included.  The trailing yield on SDY is 3.32%.
Vanguard Dividend Appreciation (VIG) – This ETF seeks to mimic the Mergent Dividend Achievers Select Index which mandates that components have increased dividends annually over the past 10 years.  The trailing yield on VIG is 1.82%.

While these yields may not seem that enticing, the strategy here is “growing” yields, not necessarily current “high” yields.  Many income investors focus on dividend growth over current yield since a very high yield is often a sign of a future dividend decrease or lack of growth, whereas a long trend of sustained increases forces capital appreciation as well as the market continues to adjust for an ever-increasing dividend payout.

High Yield Preferred Stocks

Acting as a sort of hybrid between a stock and a bond, preferreds are primarily offered by Financials, but some other industries participate as well.  To spread risk and enjoy a respectable trailing yield exceeding 7% with a monthly payout, the Preferred ETF is a good choice.  The ticker there is (PFF).

US Currency is King

In the event of extreme deflationary conditions globally, the US Dollar would continue to benefit, as we see whenever investors seek safety and reassurance.  Some options to play an improving US dollar relative to counterparts include the PowerShares DB US Dollar Index Bullish ETF (UUP) which capitalizes on relative US Dollar strength or if you want to continue to play Eurozone contagion, (EUO) is a leveraged short Euro ETF.  Just beware the negative consequences of holding leveraged ETFs over long periods of time if the trend reverses or flattens.  You lose money even with a flat underlying index due to daily volatility decay.

High Yield Investments

While some investments are yielding higher than typical high single digit current payouts, some investors fear these will be the first to experience major capital outflows and price declines when markets panic.  But for those willing to take on some volatility in the pursuit of above-market rates, consider the following high yield ETFs.

Finally, many investors who are positioned correctly and don’t mind some minor tax hassles prefer the asset class many compare to a hidden gem of income investments – MLP Investments.  Master Limited Partnerships are required by law to pay out 90% of their income to investors as with the right tax and investment planning, they could be well-suited to return double digits for prolonged periods with just minor capital appreciation.

Gold is not necessarily considered a universal inflation play, as gold investments are usually touted for their inflationary attractiveness.

Disclosure: Author is long EUO.

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