Gary,
I came across this article in Tuesday's edition of NP. You may have seen it but if not, here is the integral text. It gives weight to your concern about market direction. Hopping to hear from you soon...
Deflation looms as threat to investors
JONATHAN CHEVREAU
It is now too late to defray 1998 income taxes with a registered retirement savings plan contribution. The deadline passed at midnight last night. If you put off a long-term investment decision and "parked" your last-minute contribution in treasury bills, money market funds, or other cash equivalents, you may be glad you did. I would be in no hurry to reinvest it.
The ongoing cult of equity has been based on the twin beliefs that inflation is ever with us and that stocks are the only asset class that can beat inflation over the long run. But, according to the latest cover story in The Economist, there is a new grim reaper on the horizon: deflation. The influential British magazine quoted David Brown, chief European economist of Bear Stearns Inc. earning that in much of the world outside America, the risk of falling consumer prices [or deflation] is at its greatest since the 1930s. Inflation in its home turf of continental Europe is close to zero, the article said. And last week, Reuters news service warned that the key cog in the European economic engine - Germany - is now "in deflation territory".
Years before the Economist went out on such a limb, the ground- breaking book, The Great Reckoning, by James Davidson and Lord William Rees Mogg, warned deflation was ahead. That book and the authors' Strategic Investment newsletter, were a little too early in their call to be profitable for those who acted on the insights. For too long, global deflation has seemed unthinkable, especially with Wall Street's stock party continuing on its merry way. That's why it is noteworthy a U.S. economist, Gary Shilling has just published a new book entitled Deflation (Lakeview Publishing Co.)
If this is on the horizon, then so may the other D word - depression. The Economist says just this: "If the economies of America or Europe were now to take a sudden lurch downward, the world might easily experience outright depression, with prices and output falling together, just as they did 70 years ago".Note that sentence begins with the qualifier, "if".
Investment counselors McCutcheon Steinbach notes in its February market commentary that the deflationary trend started more than a year ago in Thailand, Indonesia, and Malaysia, then spread throughout Asia. Excess manufacturing capacity to supply Japan was financed by debt, but Japan's fiscal and demographic problems locked in and collapsed demand. Meanwhile, Russia reached the breaking point on debt service, a situation that in turn was aggravated by problems in Brazil and other emerging markets.
McCutcheon Steinbach expects volatility to remain high both on the upside and downside throughout 1999. Generally, we anticipate a much more difficult investment climate this year than has been the case for the past three or four years.
Traditionally, the asset class of choice in a true deflationary environment is bonds. But "this is not the time for bonds yet", says investment adviser Hans Merkelback, whose comments are aired on the Internet at www strategicsector.com. "The best opportunities in bonds will come along in about 10 months' time. Then profits of 20% to 30% could be in the making.... Since there is so little difference in yield between a good money market fund and one-year government bonds, I would stick to money market funds until several triggers fall into place"
While inflation rewards those in debt, deflation punishes them. So if your choice is consumption versus debt repayment, the prospect of deflation should tilt the average homeowner toward getting out of debt. A cash cushion in case of job loss is always advisable; in deflationary times, it becomes crucial.
The consumers of last resort are Americans, who are continuing to buy "toys" on the strength of the ongoing bull market That in turn fuels corporate profits and stock prices, a virtuous cycle for as long as it lasts. In Canada, we're better at saving but government tax policy discourages consumption and strangles our investment returns in RRSP's and other tax-sheltered vehicles.
But those U.S. stock returns look less than assured in recent weeks, as bond yields start to nudge higher. Last week, the Dow Jones industrial average approached but didn't quite touch its high of 9643.32 reached Jan. 8. That figure could turn out to be the other half of a double-top to accompany the previous peak of 9337.97 reached last July i7. In between was history's shortest bear market.
Now, with spring just around the corner, the bears are creeping out of hibernation. For three months, Mr. Merkelbach has been issuing alerts to investors to switch North American and Canadian equity funds to money market funds. He views the rise of bond yields past the 5.5% threshold as "one of the key monetary triggers ... from this we can with reasonable accuracy conclude that breadth, leadership, advances/declines as well as the bond yield have all confirmed a bear market.
"From now on, watch that 30- year yield and more downside leadership - the bluest of the blue chips going down - for an indication of how quick this bear market could accelerate."
Edmonton-based mutual-fund market timer Hendrickson Financial Inc. also views Wall Street as vulnerable. "U S. markets are currently trading sideways and the momentum in technology stocks is weakening." writes Darcy Mountjoy in Market Trend Follower. "Cash sitting on the sidelines has not been propelling the market. The longer this market
trends sideways, the bigger the move will be when it breaks."
The same issue of that newsletter leads off with an article by Martin Pring: "The technical underpinnings of the U.S. market continue to stand on shaky ground... Behind the optimism conveyed by the major U.S. stock indices lies a more cautionary reality."
Stephen Gadsden, an investment advisor with the Equion Group, suggests three routes. "For the faint of heart, go to cash and convert it to highly liquid, high yielding interest-bearing certificates at your local bank or trust company."
For slightly higher returns at more risk, Mr. Gadsden suggests short term bonds with duration of three years or less or short-term bond mutual funds. That way, you're more liquid and less ex- posed should interest rates start rising again. We will explore his third suggestion – gold bullion or precious metal funds – in a future column.
I have deliberately held off mentioning another factor until the end of this column. On top of all this uncertainty, we must add the year 2000 computer (Y2K) crisis, which draws nearer each day.
Last week, a draft U.S. Senate report leaked to the Washington Post described Y2K as a "world- wide crisis" and as "one of the most serious and potentially devastating events this nation has ever encountered."
Many foreign countries and U.S. economic sectors may be at significant risk for technological failures and business disruptions from Y2K, it said. The report came down hard on health care, and portrays the oil, education, farming, food processing, and construction sectors as lagging on Y2K preventive maintenance.
Investors, and especially investors in stocks and equity mutual funds, do not like uncertainty.
When it comes time to reinvest those parked RRSP contributions, show this column or the Economist to your financial advisor. Don't let him or her gloss over the issues. What you do during the next 10 months maybe crucial.
Jonathan Chevreau can be reached by e-mail at jchevreau@nationalpost.com |
