Happy New Year! January’s the time for scouring the entrails for clues on the year ahead, but making predictions for 2009 is even tougher than usual. It shouldn’t be. After all, only one question really matters – should we be more worried about inflation or deflation? Trouble is, there’s no easy answer to that question. Just look at our Roundtable experts; while our regular columnist James Ferguson believes we’re facing wholesale, Japanese-style deflation for years to come, Braeburn chairman Jim Mellon reckons that the money-printing efforts of central banks around the world could see us return to fears about inflation by the end of this year. So who’s right?
Although we’ll certainly see deflation in the short-term, I’m not convinced it’ll last long. But even if you believe we’ll follow Japan along the deflation path, it’s still worth looking at where the balance of risks lie if you get it wrong. James Montier at Société Générale points out that the US Treasuries market is already pricing in a Japan-style slump. So anything less than massive deflation means that investors buying government debt now will probably end up losing money. On the other hand, mild inflation, or even lower deflation than expected, would be good for the price of most other assets. And if one thing’s for sure, it’s that America is determined to avoid deflation by any means necessary. As Montier says, Japan didn’t start printing money (or ‘quantitative easing’ as it’s known) until seven years after deflation first hit. Ben Bernanke has hit the presses before the US has even had a sniff of deflation.
Another point is that those markets which are being left to their own devices are correcting rapidly. Retailers here in Britain – one industry that I can’t see getting any sort of government bail-out – are slashing prices and going to the wall just now. But those who survive the initial fall-out will have better pricing power. Consumers will buy less stuff, but there’ll be fewer shops to buy it from. In any case, sterling’s weakness also means shops probably won’t be able to cut prices by this time next year – imports from China will be far more costly than in 2008.
What does this mean for your investments? We can’t be sure of exactly when inflation will make a serious return, so if you have invested in gilts or Treasuries, I’d hold on to them for now, but don’t invest new money. Instead (and this is one thing that both James and Jim agree on), stocks with solid balance sheets and high dividend yields – such as BP – look attractive. We’re more cautious on broader markets, but still rate Japan a buy – it’s cheap, it has a strong currency, and the economy is in far better shape than its Western counterparts. As for protection from inflation – well, we’ve backed gold for years, and we’re not about to change our minds this year.