As the Federal Reserve cut interest rates to the bone and our nation cranked up the money-printing presses in an attempt to stave off recession, cries went out about the possible inflationary effects of such efforts. Many predicted an unavoidable period of runaway inflation for our economy. But thanks to lingering economic weakness, inflation fears have been largely unrealized. In fact, the fear of deflation is arising in some quarters. So which force do we need to be more afraid of?
Deflated expectations
While I don't want to downplay the longer-term risks of inflation that are lurking for our fragile economy, right now, inflation simply isn't a threat. The Consumer Price Index, a measure of the level of prices for goods and services in our economy, fell in June for the third straight month. And while core CPI ticked up slightly, overall levels of inflation remain very low and show few signs of breaking away drastically. Although many are quick to throw the deflation concept back onto the table, the numbers don't seem to be pointing in that direction -- at least not yet.
It's important to distinguish between disinflation, a decrease in the rate of inflation, and deflation, an outright decrease in overall price levels. Disinflation is what we've seen over the past few years. Overall, prices haven't fallen so much as they have crept up at a slower and slower pace. So while over the long run inflation is likely to make a comeback, right now pricing pressures should remain relatively slack. And that has some important implications for where you should be investing now.
Yield to the high-yielders
Lower levels of inflation mean companies aren't as able to raise their prices, thus keeping downward pressure on sales and earnings. That means lower returns for investors. One way to offset this trend is to supplement your portfolio's earning power with dividend-producing stocks. Thanks to a market recovery that has so far favored more speculative fare, there are a number of high-quality dividend stocks now selling at meaningful discounts relative to their peers and to the market. ExxonMobil (NYSE: XOM) sports a 3% dividend yield and a P/E ratio of just over 13, while Chevron (NYSE: CVX) clocks in with a 4% yield and a P/E of just 10.9. Outside of the energy sector, McDonald's (NYSE: MCD) is another interesting contender, with a P/E below its industry's average and a reasonable 3.2% dividend yield.
Likewise, it may be smart to pick up a few names that have more pricing power now. Somewhat defensive plays that focus on basic consumer staples could be a good choice in the near term. Names like Procter & Gamble (NYSE: PG) and Wal-Mart (NYSE: WMT) are two good choices in this space. Both companies are dominant players in their industries and boast hefty market share. Procter & Gamble sells products that people need, no matter what the level of inflation or deflation, while Wal-Mart should continue to be a low-cost leader and already has the economies of scale to avoid pricing pressures that may emerge on higher-end retailers. Not to mention that both companies throw off a nice little dividend as an extra boost for investors.
A global reach
Beyond our domestic borders, there is another important avenue that investors can capitalize on when prices are stagnating here at home -- the growing power of emerging markets. Even as the U.S. economy struggles to eke out growth and raise prices, fast-growing countries like China and India should continue to experience rising domestic demand. Thus, investments in these and other developing nations can serve as a hedge against deflation or disinflation in the U.S. Just be warned that emerging-markets investing comes with significant risks, so if you're a more conservative type, keep your allocation here on the smaller side.
Diversification is vitally important when buying stocks in emerging markets, so think big and think broad with low-cost exchange-traded funds. Some of the best ETFs in this space include Vanguard Emerging Markets Stock (NYSE: VWO) and iShares MSCI Emerging Markets Index (NYSE: EEM). But be prepared for some bumps in the road, because emerging markets have had quite a run-up in recent history and are more fully valued now than in years past.
Ultimately, while inflation is waiting for us out there on the horizon, the risks are weighted away from rising prices for the immediate future. I'm not seeing imminent danger of deflation, but investors should be prepared for restrained pricing power for now. With a few carefully chosen investments to supplement the core of your portfolio, you can ride out this period of disinflation and still be prepared for the day when inflation once again takes center stage.
