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Is inflation really a must?

Posted At : April 23, 2009 10:52 AM

Over the next decade, the critical element in any investment portfolio will be the correct call regarding inflation or deflation. Despite near term deflation risks, the overwhelming consensus view is that “sooner or later” inflation will inevitably return, probably with great momentum. This inflationist view of the world seems to rely on two general propositions. First, the unprecedented increases in the Fed’s balance sheet are, by definition, inflationary. The Fed has to print money to restore health to the economy, but ultimately this process will result in a substantially higher general price level. Second, an unparalleled surge in federal government spending and massive deficits will stimulate economic activity. This will serve to reinforce the reflationary efforts of the Fed and lead to inflation. These propositions definitely make sense. However, why is gold not going up? Interest rates always lead and what are they not rising? It is starting to become clear to me that assets are being destroyed faster than the government can inflate. Everybody says that inflation is obvious. I learned long ago that if it’s obvious…it’s obviously wrong!

Betting on inflation as a portfolio strategy could be a very bad a bet. If this all sounds complicated you are right, it is. The bottom line, however, is that it is totally incorrect to assume that the massive expansion in reserves created by the Fed is inflationary. Economic activity cannot move forward unless credit expansion follows reserves expansion. That is not happening. Too much and poorly financed debt has rendered monetary policy ineffective.

Investment Strategy – Be prepared, take action and don’t get complacent
I have been positive for nearly as long as this rally has been in force, (which surprises me about that Dr. Doom comment?), and I continue to be for the immediate term. Although, this rally is getting tired and should see a sizable correction sometime soon. Rallies in Bear markets often last 2-3 months, and at this point I would not expect much more. There are many places for your money that are doing very well, but this is not a market you want to buy and hold from today’s level. High dividend stocks and corporate bonds offer a very attractive yield at the moment. Use this period of relative stability to re-examine your portfolio and tweak it for the current bear market and NEXT bull market. DO NOT get complacent. DO NOT procrastinate. If you are sitting on a portfolio built before this economic Tsunami hit, you probably need to make adjustments. If you lost more than you thought you should, could or wanted to, you definitely need to make some adjustments. If you’d like a free 2nd opinion, just let me know. You don’t want to go it alone and it’s hard to find someone that knows what they are doing.

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