What is Disinflation?
Disinflation occurs when the rate of inflation is decreasing. Most investors don’t understand that historically it is the direction of inflation, not the rate of inflation, that has the largest effect on investment returns.
For an asset allocation guide of other inflation scenarios we also look in past and future posts at:
Investing During Disinflation
Disinflation provides the widest variety of favorable asset allocation choices for investment portfolios. Historically, both stocks and bonds have done well when the rate of inflation is falling. An exception would be the few time periods where the inflation rate becomes negative, called deflation. This article is about time periods when positive inflation rates are falling.
Falling inflation rates can be caused by a sound and/or slightly restrictive monetary policy, stable credit conditions, and/or conditions where supply is equal to demand. In reality it is usually a combination of these and other unknown factors that causes inflation rates to begin falling from higher levels.
If an investor recognizes an inflation trend that is decelerating, and believes it will continue, they should consider the following investment guide for portfolio allocations. Always check with your financial advisor to be sure an investment is right for your individual situation.
Disinflation Investing Guide
Large-Cap Stocks – Overweight quality dividend growth stocks. Underweight stocks with overseas exposure that might be hurt from a rising dollar.
Small-Cap Stocks – Small companies usually do well during inflation. Over weight small value stocks, underweight expensive growth stocks.
Foreign Stocks – Markets that sell products to the United States usually do well. Emerging Markets in particular are well positioned to supply goods to a healthy U.S. consumer market.
Corporate Bonds – Falling interest rates provide a favorable atmosphere for high quality bonds. Underweight Junk Bonds.
Treasury and other High Quality Bonds – Safe investment that, as interest rates fall, provide capital gains in addition to paying interest.
Treasury Bills – Underweight. Low and falling rates make Bonds a better investment.
Inflation Indexed Bonds – depend on nominal rate. Knowing when to buy TIPS is always important. Bonds may provide higher capital gains than TIPS during periods of disinflation.
Commodities – should be underweighted. Only invest in commodities with growing demand and limited supply.
Gold & Silver – Under weight or Avoid. Contrary to what most people think, gold and silver are not good long term investments. Their main advantage is they maintain buying power over long periods of time. Falling inflation rates are not the ideal time to own precious metals.
Real Estate- Falling interest rates can provide a great boost to real estate values. Location is a more important factor than ever with inflation rates falling.
Summary
Asset Allocation is the most important investment decision you can make. Periods of disinflation can provide the most favorable atmosphere for a large number of investment choices. However, avoiding the wrong investments can be just as important as the investment chosen. Adapting your asset allocation to the inflation cycle can provide above average rates of return for your portfolio. Investing during disinflation requires an asset allocation guide that takes advantage of falling interest rates and economic stability.
| AAAMP Blog by Ken Faulkenberry | |
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Ken Faulkenberry earned an MBA from the University of Southern California (USC) Marshall School of Business with an emphasis in investments. Ken has 25 years of investment experience and is dedicated to helping people with self-directed investment management through the Arbor Investment Planner. His asset allocation strategies have an outstanding performance record. |
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