A huge debate has split investors into two camps: those who believe that deflationary pressures will lead us into another Great Depression, and those who fear that huge amounts of government stimulus will cause inflation on a scale we haven't seen for 30 years. But if you look to the credit markets for a sign of which way prices may be headed, things couldn't look more normal.
Putting their money where their mouths are
Predictions of future inflation are all over the map right now. One place you can look for objective figures is the Treasury bond market. Specifically, you can choose from two different types of bonds: traditional bonds that simply pay regular interest and pay back your original investment at maturity, or special bonds known as TIPS, which are indexed to inflation and pay you an inflation-adjusted amount at maturity rather than simply returning what you initially invested.
If you compare the yields across both types for a given maturity date, you'll get the market's prediction for what inflation will be over that time frame. Here's what those predictions are right now:
Period |
Implied Inflation Rate |
---|---|
Now to 2011 |
(0.01%) |
2011 to 2012 |
0.97% |
2012 to 2013 |
2.08% |
2013 to 2014 |
1.84% |
2014 to 2015 |
2.51% |
2015 to 2020 |
2.16%* |
Source: WSJ, author calculations.
Based on Treasury yields as of July 13.
*Annualized.
None of those calculations looks particularly scary in either direction. In fact, policymakers would likely see an inflation rate around 2% as close to perfect in terms of promoting growth while avoiding any overheating price pressures.
A seesaw in perfect balance
Unfortunately, concluding that this implied future inflation is destined to come in not too high and not too low is going too far. All it tells you is that somewhere around 2% is what market participants expect to see on average. What you can't see from these figures is the dispersion of those expectations.
For instance, say half of all Treasury bond investors expected deflation of 2% annually over the next 10 years, while the other half expected inflation to move up to a 6% annual rate over that period. The average expectation would be around 2% inflation -- but no one would expect that outcome.
Prepare for whatever comes
One solution investors can use is to prepare for both possibilities. Here are some thoughts on how to do that.
First, gravitate toward companies with cash on their balance sheets. Google
Second, focus on companies that have the most control over their pricing. Altria Group
Lastly, for the fixed-income side of your portfolio, mix in some inflation-adjusted bonds with traditional bonds. The iShares Barclays TIPS Bond
Be ready
Even if you can't guarantee a 100% accurate prediction about which way prices will move in the coming years, that doesn't mean you can't invest well. By looking at both sides of the inflation/deflation coin and planning for either outcome, you'll put yourself in the best chance to profit no matter what happens.
Don't be scared to take smart risks. Fool Anand Chokkavelu has tracked down six tantalizing stocks that most investors are too frightened to buy.