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Deflation? Bring It On!

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Judging from the Federal Reserve's rate cut yesterday, policymakers have put the fear of deflation above all other worries the struggling economy faces right now. Yet, for one group of investors, deflation would provide long-awaited relief from unending the unending price increases and meager savings rates they've faced for years.

Retirees, who are well known for their generally conservative investing strategies, have reaped the rewards of their caution during 2008. In a year during which the markets have lost over a third of their value, retirees who put safety above all else are sitting on decent gains -- and salivating at the idea that their savings might actually go further in the years to come.

Why deflation hurts most of us
For the overall economy, deflation brings a host of horrors. For instance, when prices are falling, companies that keep large amounts of inventory relative to their sales suffer. Until those companies can sell their inventory, its value drops for every day they hold it.

The chart below shows companies with unusually slow turnover rates, as indicated by the ratio of their quarterly sales to the value of their inventory.

Company

Inventory Turnover 

Tiffany (NYSE: TIF  )

0.69

KB Homes (NYSE: KBH  )

0.95

Philip Morris International (NYSE: PM  )

1.11

Constellation Brands (NYSE: STZ  )

1.12

AutoZone (NYSE: AZO  )

1.36

Titanium Metals (NYSE: TIE  )

1.49

Coach (NYSE: COH  )

2.08

Source: Capital IQ, a division of Standard and Poor's. Figures for most recent quarter.

For consumers, deflation makes paying down debt increasingly difficult, as employers cut wages to compensate for lower profits. At the same time, if you have to sell assets to reduce your debt, deflation means you get less in proceeds from your sale.

The other side of the coin
Seniors, on the other hand, love deflation -- for a variety of reasons:

  • Bonds skyrocket. For retirees who've traded risk for a fixed return, inflation is their biggest fear. But when prices are actually falling, you get a double bonus. You collect interest over the years, and when the bonds mature, you get your principal back -- when it has more purchasing power.
  • Income stays stable. Falling wages don't affect you if you've already stopped working. And while deflation might threaten some inflation-adjusted investments, such as TIPS, it appears that deflation wouldn't cut Social Security or other government benefits payments.
  • Saving gets rewarded. For years, retirees have suffered through having to accept low rates on CDs and other investments. Now, though, those who've capitalized on fairly high CD rates offered by cash-strapped banks will receive an even higher real return as inflation disappears.
  • Costs are contained. Although it's far from clear whether the major costs for seniors -- things like health care, travel, and housing -- would all drop during a general deflationary period, seniors would appreciate even any move toward price stability after years of seeing those expenses rise faster than the inflation rate.

How to prepare
If you're convinced that deflation is here to stay, then the biggest key for seniors is to get rid of any debt you have left outstanding -- especially if it's big enough that making payments is difficult. You don't want the possibility of seeing your debt expand at the same time those dollars are becoming more valuable.

Conversely, locking in the relatively high rates that are currently available on fixed-income investments is a great move for the conservative side of your portfolio. As the credit crunch eases, you can expect bank rates to move down to levels more in line with ultra-low Treasury rates -- which will threaten your income once more. For now, you can still get rates of 4%-5% on fully-insured CDs -- but don't expect them to last.

Deflation has the Fed and others running scared, but seniors can handle it more easily. If you take the right steps, you'll continue to find yourself in the enviable position you've enjoyed during 2008.

For more on protecting your retirement, read about:

Whether you're retired or years away from retirement, our Motley Fool Rule Your Retirement newsletter can help you. Each month, you'll get new tips to help you save more and preserve what you've already saved. Take a no-obligation test-spin free for 30 days and see how Rule Your Retirement can help you.

Fool contributor Dan Caplinger isn't rooting for deflation. He owns shares of Philip Morris International. Titanium Metals and Coach are Motley Fool Stock Advisor selections. Try any of our Foolish newsletters today, free for 30 days. The Fool's disclosure policy never sees a price increase.


Read/Post Comments (4) | Recommend This Article (15)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 17, 2008, at 5:36 PM, Database wrote:

    Dan,

    There are three very serious logical fallacies in your analysis.

    1. The ratio should be compared against sector averages; otherwise, you are comparing apples to oranges. For example, Basic Materials sector average is 0.85 (this is because most of the Basic Materials sector inventories are in the form of input raw materials, not finished products). If you use the ratio as it is intended to be used, you will see that Titanium Metals inventory turnover ratio is twice as high as the sector average.

    2. Your second logical fallacy is that you do not understand that lower input costs (lower energy and raw material costs) improve profits.

    3. Your third logical fallacy is that you assume that demand is static and not dependant on price. Contrarily to your weird logic, usually lower prices bring more demand.

  • Report this Comment On December 18, 2008, at 3:38 PM, Kopanitsa wrote:

    To 'Database':

    Thanks for your analysis, however please try to not season contrary views with put-downs of the author (unless it is the author's behavior that you are disagreeing with).

    A useful rule of thumb is to avoid the words "you" and "your" when stating disagreeing viewpoints.

  • Report this Comment On December 18, 2008, at 3:39 PM, Kopanitsa wrote:

    To Dan:

    Where do you still see 5% CD rates?

  • Report this Comment On December 19, 2008, at 9:53 AM, vielglueck wrote:

    I agree with "database".

    The ratio by itself does not tell you anything.

    The ratio must be compared against industry and sector averages. A low turnover implies poor sales and a high ratio implies either strong sales or ineffective buying.

    TIE Inventory Turnover (TTM) is 1.48

    RTI Inventory Turnover (TTM) is 1.45

    Basic Materials Inventory Turnover (TTM) is 0.50

    Mining & Metals Inventory Turnover (TTM) is 0.38

    (Source Reuters)

    As one can see, TIE and RTI Inventory Turnover ratios are 3 times better than Basic Materials Sector and 4 times better than Mining & Metals Industry.

    In addition, Motley Fool fails to recognize that most of the inventories of TIE are raw materials inventory -- lower raw material costs improve profits (deflation of raw materials is good for TIE profits because prices for raw materials have decreased much faster than prices for finished products).

    Moreover, Motley Fool fails to recognize that lower prices create more demand (demand is dynamic) -- basic law of economics.

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Dan Caplinger
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Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on Fool.com. With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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