Economic Tsunami, the Second Wave:
Prepare your portfolio for the next tidal wave

By Keith Springer

We are living in extraordinary times. The demographics of the aging baby boomer generation and the massive government interventions have changed the rules for investing. Over the next several years we will be gyrating back and forth between the different economic cycles of deflation, inflation, re-flation and stagflation, and each will require an entirely different investment strategy.

What’s next? Deflation!  Deflation is brought about by a systemic slowdown of an economy that brings prices "lower" for goods and services. That is practically unheard of in a capitalist economy, except at the end of a generational cycle every 40 years or so, such as we are currently experiencing with aging Baby Boomers. The situation is exacerbated by excessive leverage, which is essentially too many people (and governments) with too much debt. The process of resolving this excess is called “deleveraging”, the massive elimination of credit and debt throughout the economy. Deleveraging by design is “deflationary”, which is bad news for stocks!

The scary part of a deflationary investment environment is that it is completely foreign to today's investors. Very few are familiar with what is necessary to be successful during a deflationary period, and most will be caught dangerously short and lose their life savings.

The primary cause for deflation is the demographics of the aging Baby Boomers. Demographics tell us that:

•  People do very predictable things at different times in their lives, with peak spending occurring at approximately 48 years of age

•  The populations of the U.S. and the developed world are aging

•  As people age, they naturally spend less, generating less demand for goods and services.

•  Less demand leads to decreased supply, a.k.a. production; less supply means fewer people are needed in the workforce.

•  The deflationary spiral continues until a generation comes along that is big enough to fill the shoes of the Baby Boomers.

•  That generation is the Echo-boomers, the children of the Baby Boomers, who will not reach their peak spending years until 2023.

The massive deleveraging process that the world is currently going through is undeniable.

•  US Banks are expected to cut an additional $1.5+ trillion worth of credit lines.

•  States are set to lay off one million to two million more people this year.

•  The new European austerity programs, ones which we will have to adopt as well (and soon!), will reduce consumption and perpetuate the deflationary spiral.

•  Inflation continues to be subdued despite the massive government spate of monetary printing presses in overdrive.

•  Overall, more than $10 trillion of consumer and $20 trillion of corporate credit will vanish.

Inflation misconception: Given the tremendous amount of borrowing and spending by world governments, many people feel that inflation is inevitable. It is true that the government is printing and spending like mad, trying its hardest to create inflation. However, what is essential for investors to understand is that the government’s attempts simply cannot create assets as fast as they are being destroyed. That’s deflationary, not inflationary. Eventually they will succeed which will be a concern down the road, but be not for while.

Portfolio Strategy: This is a very dangerous period, and investors must employ a "tactical" investment approach, as the old fashion buy-and-hold (buy-and-hope) approach will again prove disastrous. For instance: bonds and cash would be decimated by inflation, but may be very profitable during deflation. On the other hand, a portfolio of stocks and commodities would do well during inflation, but catastrophic during deflation. And of course, there will be a time in the near future where you will want to be in cash, so you must have an exit strategy.

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