Bracing For Deflation

By on August 2, 2010

Some high profile investors are concerned about deflation, which could prove problematic for economic growth and corporate profits. The worrywarts include Bill Gross, Jeremy Grantham, and hedge-fund managers David Tepper and Alan Fournier.

Mr. Gross urges investors to focus on cash flows that are “relatively certain,” such as dividends and interest from stocks and bonds of quality companies.

Although there is concern out there, the general feeling is that the odds aren’t skewed towards a deflationary outcome.

Deflation is no sure thing, the investors say. Mr. Tepper says that if the U.S. economy expands 1% or so over in the next few years, deflation and troubles for stocks will arise. Growth of 3% would boost profits and stocks, he says.

At Pimco, Mohamed El-Erian, the firm’s chief executive and co-chief investment officer, says “the risk of a deflationary spiral has increased, but it is still not the most likely scenario.”

He says investors need to prepare for an unusually wide range of possibilities. The risk of so-called fat tails—or extreme outcomes—including a bout of prolonged deflation, are “not insignificant.”

Source: The Wall Street Journal
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