I opened up the “Money & Investing” section of the WSJ today and read in big, bold letters “Big Investors Fear Deflation.” The risk of deflation seems to be the hot topic recently, so I thought I’d throw in our two cents.
We believe deflation is certainly a possibility in the short run, particularly when it is believed to be coming. Deflation can be a self-fulfilling prophecy when purchases are delayed in anticipation of lower prices, exacerbating the problem. In spite of this, should it happen, we find it unlikely that it will become a serious issue because we believe it would be short lived. “Helicopter” Ben has already clearly outlined his playbook years ago at his speech before the National Economists Club in Washington, D.C.. He has expressed he would rather take radical steps to flood the economy with money and debase a currency than face deflation. On the other hand, we do not question the long-term inflationary pressures which are building as a result of our fiscal and monetary policies (See The National Debt Road Trip and Keynesian Economics blogs) – but who knows when that will materialize. Regardless of what happens, we believe carefully selected, undervalued companies with pricing power will offer the best returns in the long run. This is why we prefer to own a cash generating asset that can adapt with the environment, as opposed to owning bonds that cannot adjust their coupons or owning a hard asset such as gold (see Gold – an investment or speculation?).
One thing is certain – this is a time of great uncertainty. The abovementioned article was tilted towards favoring the purchase of fixed rate bonds to protect from the onset of deflation. Ironically, in the prior issue of the WSJ over the weekend, there was an article titled “Are Bonds Expensive? Stocks cheap? Both?” This article had the complete opposite opinion and favored stocks because the gap between bond yields and stock cash yields has opened up significantly. Where do we stand? On a relative basis, we acknowledge this wide gap and are somewhat boggled why someone would prefer bonds over stocks unless they truly thought deflation will become a malicious problem. Bonds appear to be in a bubble, and certainly don’t look like the less risky asset they are always assumed to be. However, this is not to say we believe stocks are cheap on an absolute basis by any stretch. If you’ve been a frequent reader of our blogs and letters, you already know where we’re coming from (read “Tidal Wave Investing” section in our Q1 2010 Client Letter, pages 12-20 in our Q2 2008 Client Letter, or my blogs Back to the good ol’ days? and Mosquito in a Nudist Colony). In fact, the broad market is trading at levels that have been considered prior market peaks. To read it from a slightly different perspective, a friend of mine, John Hussman, whom I deeply respect, recently made some good commentary regarding this very thing. Scroll about halfway down and read under the section Betting on a Bubble. At the same time, we’ve never seen so many quality companies trading at such low valuations simultaneously. Bottom line, we believe this is a market where stock pickers will prove to be worth their salt.
Disclaimer: The specific securities identified and discussed should not be considered a recommendation to purchase or sell any particular security. Rather, this commentary is presented solely for the purpose of illustrating YCG’s investment approach. These commentaries contain our views and opinions at the time such commentaries were written and are subject to change thereafter. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. These commentaries may include “forward looking statements” which may or may not be accurate in the long-term. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable. Past performance is no guarantee of future results.