Great commentary as usual from Jeff Saut’s most recent weekly missive.  In it, Mr. Saut provides the differing opinions of several market experts on the big deflation vs. inflation debate.   As regular readers know, I am far from worried about inflation running out of control mainly due to continuing negative trends in the labor market, weak borrowing trends and the private sector’s debt induced weakness.  It’s always important, however, to get the perspective of several differing sources and Mr. Saut provides some excellent opinions.

First up was Dr. Lacy Hunt of Hoisington Investment Management:

“Dr. Hunt began by stating that the current conventional beliefs are: monetary/fiscal policy is wildly stimulative and therefore inflationary; our debt problems are behind us; and the current account deficit is going to explode with a concurrent dollar dive combined with higher interest rates. Lacy went on to suggest that all of those beliefs are false. Certainly the Federal Reserve has been expanding its balance sheet, but the velocity of money (the frequency with which a unit of money is spent in a particular period of time) has been cut in half. Consequently, M2 money supply is growing at its slowest rate in decades, which is not sufficient to promote sustained GDP growth (according to Lacy Hunt). Speaking to fiscal policy, Lacy stated that the government spending multiplier is less than 1 and the tax multiplier is actually negative. This means if taxes go up by $1 it takes more than dollar’s worth of spending out of the economy. Lacy concluded that if over indebtedness is the problem, how can taking on more debt be the cure? He believes the risk premiums are, and have been, insufficient to buy stocks and therefore bonds are his preferred investment.”

Paulson and Co. was represented by Claudio Macchetto.  Paulson’s firm has been wildly bullish since 2009 and is now in the v-shaped recovery camp:

“Refuting Dr. Hunt was Paulson & Company’s Claudio Macchetto, who is bullish on stocks, thinking we are in a sustained economic recovery that might even be V-shaped. While he put the odds of a double-dip recession at only 5%, he did suggest that sovereign debt defaults are a real risk. He continued by noting the government is “printing” its way out of the problem (money creation). He thinks this will foster an inflationary environment accompanied by an increase in the velocity of money. One interesting point Claudio made was that last quarter banks loosened their lending standards for the first time in 10 quarters.”

David Rosenberg is bearish as most of us know and expects deflationary pressures to continue in the coming years:

“Next was the always entertaining, and brilliant, David Rosenberg, who began talking about heightened volatility. Still, over the longer-term, David thinks the equity markets are not going anywhere. His reasoning is that because everything is priced off of nominal GDP, stocks will go nowhere since GDP growth is going to be very low. To be sure, we have an economic recovery largely due to the government’s simulation packages; however, it is temporary and the weakest ever (according to David). Like me, he thinks there is an asset “mix shift” toward income by the retiring baby boomers. He recommended protecting portfolios from his envisioned deflationary outcome by making certain portfolios throw off “income.” Rosie concluded by stating, “The day of reckoning is coming.””

Dr. Gary Shilling is equally bearish and maintains the same deflationary perspective:

“Like most of the speakers, Dr. Gary Shilling thinks deflation is the correct “call.” While his case rests on many “footings,” his major tenant is that the nation’s 25-year borrowing and spending binge is over as the retiring boomers focus on income. Gary stated that every half of a percent rise in the savings rate takes 1% away from GDP growth. Accordingly, he thinks we are in for a low growth environment combined with a whiff of deflation. For such an environment he likes investing in treasury bonds, consumer staples and food, small luxuries, the U.S. dollar, investment advisors and financial planners, factory built housing and retail apartments, healthcare, productivity enhancers, and North American energy companies.”

The most interesting commentary came from John Mauldin’s partner Jon Sundt.  Mr. Sundt spoke about the ways to play the potential fallout of inflation OR deflation.  Mr. Sundt believes market participants are best prepared for the coming ‘flation by investing in three buckets of long/short funds, global macro funds and managed futures funds.  I fully agree.  Hedging strategies should continue to produce excellent returns when compared to traditional buy and hold strategies over the coming decade:

“Plainly, the debate of the conference was deflation versus inflation with most participants coming down on the side of deflation. Yet as an investor, how do you position your portfolio to benefit from either outcome? That question was answered by John Mauldin’s partner Jon Sundt (CEO of Altegris). He began by talking about his surfing trips to Indonesia, where the trick is to bring the right surfboards for conditions. Typically Jon brings a big wave board and a small wave board. However, with them he always takes three “all weather” boards. Expanding on that analogy, he proceeded to discuss why historically equal amounts of money placed into three select “investment buckets” has had the best record of successfully navigating all market environments. Those “buckets” are a long/short equity sleeve, a global macro sleeve, and a managed futures sleeve. Jon suggested that an equal dollar investment in each of these vehicles should position portfolios for the best risk-adjusted performance under either outcome (inflation or deflation), and I agree.”

Source: Raymond James