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21 January 2015

Deflation (And What to Do about It) in 13 Charts

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Posted In: Economics, Equity Investments, Fixed Income, Future States, History & Geopolitics

Deflation is a thing now.

At least for the moment, it’s a statistical truth in some places — I’m looking at you, eurozone. But what does that mean? What’s causing it? And most importantly if you’re an investor, what the heck do you do about it?

Let’s find out. And be advised: if you’re not particularly concerned about deflation, you should probably get your head examined. Though you might have more fun checking out the other charts post I wrote recently.

The warning that I published in that article applies triply to these charts: They are just pretty pictures! If you read this and then use it to make investment decisions without verifying its content, you’ll literally wipe the smile right off of my face.

And as usual, if you dig this sort of stuff (and promise to think for yourself), you should subscribe to the Enterprising Investor.

In case you were wondering if it was just you (or really just me) who’s thinking about deflation, you’re incorrect. Google search volume for “deflation” is rising to levels not seen since 2009.

And the regional breakout is interesting too. Austrians rank second in concerns about deflation after Nigerians . . .

. . . but empirically are the least deflated members of the European Union. I noted last time that they were attracting a crazy share of immigration inside the eurozone, so it might be worth digging in a bit more. Anyone want to grab a drink in Vienna?

The picture of the aggregate doesn’t look good at all though.

https://twitter.com/lebullmarche/status/553530548095045636

And the growth in negative-yielding government debt is clearly alarming, though it’s important to remember that a negative stated yield and an investor return are not the same thing. In a deflationary environment, money gets more valuable. Getting €.99 back in a year on your investment of €1.00 might be a pretty good deal if those €.99 can buy a whole lot of stuff all of a sudden.

Let’s zoom out a bit and think about what deflation really is. I find this 800-year chart of the Swedish consumer price index (CPI) oddly comforting when I remember that humans actually managed to live through the multicentury period of pronounced inflation and deflation that is pictured here. That said, it does highlight that we live in an unusual era of monetary peace. The article that this tweet links to also includes a great chart relating the US CPI to stock performance (spoiler: no relation) as well as the excellent observation that while the world was on the gold standard, deflation had to follow inflation: you couldn’t change the monetary base at will!

https://twitter.com/NickatFP/status/556123628509483008

Still, it does look like we Americans may be joining our colleagues in Europe sooner than we’d like. A whole host of US economic data has disappointed.

https://twitter.com/AlexCKaufman/status/556133041857658881

And this time series of the CPI doesn’t look cheery, although it’s worth noting that it managed to correct back in 2011, and the Europeans are talking about a “big” round of quantitative easing (QE).

That’s not the only thing we need to think about though. The US dollar has rallied massively and oil is getting crushed. Are we really surprised by an environment where individuals are paying less for things?

It is also somewhat typical for us to go through a period when initially rosy estimates are rolled back. We literally do it every year, since forecasts are really just a way of having a conversation about expectations and it’s natural to be optimistic.

There has definitely been an impact on the earnings guidance that firms have been issuing though. It’s possible that this is reflective of investor relations teams’ tendency to seek lower expectations that are easier to exceed, but the zero line in this time series is clearly related to recessions.

Just like this one.

So what do you do? It depends, but it’s worth remembering that things still have a tendency to grow over long time horizons, despite disastrous events and unbelievable volatility.

https://twitter.com/FirstWordNick/status/555790680392740864

Some changes are massive and irreversible though, like last week’s “cliff” in the Swiss franc. In the game between Markets and the Swiss National Bank (SNB), my colleague Ron Rimkus, CFA, puts the score at 1–0 markets.

https://twitter.com/thereaibanksy/status/554867634853150721

The trick for enterprising investors will be to stay focused on what’s really important. In life, that means being a positive influence on yourself and those around you. In investing (whether the outlay is your dollars or your time), that means focusing on what you’ll get back later from what you part with, and what you’ll be able to do with that. In a deflationary environment, money increases in value automatically, which stalls investment and defers consumption.

What’s the best trade you can put on in your personal account to ensure your financial success in such an environment? Make sure you’re making a profit on your life. It looks like money will only get more valuable.

If you liked this post, don’t forget to subscribe to the Enterprising Investor.

All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©iStockPhoto.com/FrankRamspott

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About the Author(s)
Sloane Ortel

Sloane Ortel is the founder of Invest Vegan, an ethics-first registered investment adviser that manages distinctive discretionary portfolios of public equities on behalf of aligned individuals and institutions. Before establishing her own firm, she joined CFA Institute’s staff as a sophomore at Fordham University and spent close to a decade helping members adapt to a changing investment landscape as a collaborator, curator, and commentator. She is also a co-host of Free Money, a podcast for sustainability-oriented investors with a sense of humor.