BY PATRICK WATSON
The global economy is stuck in neutral in spite of the “whatever it takes” efforts of central bankers.
The eventual fallout from near zero or even negative interest rates is a huge unknown. Given the lack of historical precedent, even the best and brightest market observers admit it’s hard to create useful macroeconomic models.
In theory, low interest rates encourage lending. This, in turn, supports spending and should boost economic activity.
There is a limit, though, to how low interest rates can go… and for how long. A growing number of critics say that we’ve gone well beyond the limits of this low interest rate experiment.
But, given that the Fed is not apt to upset the apple cart pre-election, don’t expect to see another interest rate hike until at least December… if at all.
This is how deflation hurts you and the economy
Deflation is when the prices of goods and services fall. Lower prices mean your money will buy more things, so deflation actually sounds pretty good, right?
Well, not really…. Think about how the expectation of falling prices affects consumer behavior.
If goods are plentiful, you’d be crazy to buy today what will cost less next month. So, you put off or forgo spending in favor of saving money.
But when consumers don’t spend, economic activity shrinks. This is the dangerous “deflationary cycle” that economists warn about. It happens when a consumer-spending boycott makes an economic slowdown worse.
Keep in mind that deflation has been a part of most major depressions. The initial causes of deflation include productivity increases that result in an oversupply of goods, debt deleveraging, or a scarcity of money. But, consumer behavior takes the greatest toll on an economy.
The Fed is way behind the curve after eight years of bowing to market whims. A recession and continued deflation are likely, so you need to take steps to protect your investments.
Here are the three best investments for a recessionary and deflationary climate.
Long-Term US Treasury bonds
Deflation favors lenders. That means you should avoid borrowing. It also means that you should only loan your investment capital to the most creditworthy parties… like the US government. In other words, buy long-term US Treasury bonds.
Right now, interest rates are very low by historical norms. Yet, the Fed has been sending signals that it is prepared to use negative rates if necessary. A recession would certainly panic the Fed into using them.
So, rates might be low today, but they can go lower still. As rates fall further, the value of existing bonds will rise while they pay out some income. This sure beats watching an asset that is correlated to the broader markets or economy lose value.
Physical Assets Like Gold
In times of deflation, it is best to own assets where supply is not increasing. Precious metals (such as gold or silver) are one clear example. By the same token, you want to own physical bullion rather than shares of a gold mining fund or ETF.
Gold coins or bars (in a secure safe or bank safety deposit box) are accessible assets that should hold their value in a recession. Precious metals are even more likely to appreciate if a classic deflationary cycle starts to kick in.
“All Weather” stocks
In a more middle-of-the-road scenario like a slight recession and slow growth, you might consider hedging your bets. One option would be “all weather” stocks like the defense sector and consumer staples.
These sectors tend to perform relatively well during economic slowdowns… but that doesn’t mean you can count on history repeating itself. Make sure you take a long hard look at every stock you own or are considering. Then, project the stock price after a two-year recession. Don’t buy (or keep) it unless you can live with that price for at least a few quarters.
Use today’s most powerful market trends for steady income and capital gains: Discover one of the most “bullet-proof” sectors with great upside… the low-risk way to take advantage of Europe’s economic crisis… the picks and shovels of biotech… and more. Click here to learn more.