When the market moves, whether up, down, or in circles, there are terms to describe these dubious economic fluctuations. Here, we will discuss two of them, deflation and disinflation, and why investors should plan for both.
Deflation is the opposite of inflation. It is a term used to outline the decline in the price level across the economy, not the growth rate of the price level (disinflation). Deflation can be triggered by a decrease in the supply of money and credit, growth in productivity and the abundance of goods and services, and a decrease in aggregate demand.
One thing to remember is that, according to the Federal Bank of San Francisco, it is relatively difficult to differentiate between low inflation and modest deflation. This can occur when biases arise in the measurement of the Consumer Price Index (CPI), which is normal.
A couple of significant periods of deflation occurred, for example, between the years 1930 and 1933 when prices dropped an average of about 7% each of those years. This period was known as The Great Depression. In the 21st century, from December 2007 to June 2009, the country experienced what was known as the Great Recession. The reason for this happening is not known for sure, as it could have been a number of factors; however, economists have speculated that the unusually high cost of borrowing may have been a major catalyst.
Disinflation is a temporary slowing of the rate of price inflation. This could occur because of technological or productivity advancements, a curtailment in the money supply, or companies increasing prices at a slower pace within a contracting business cycle. Think of it as a productivity surge boosting real GDP growth, yet the inflation rate continues downward. It is not something investors should be very concerned about. Disinflation is not uncommon and can viewed as normal during healthy economic stretches.
To clarify, inflation and deflation refer to the movement of prices. Disinflation is the change in the rate of inflation. Inflation is the U.S. dollar's purchasing power and how expensive goods and services have become over a specified period.
During periods of disinflation, stocks and bonds tend to perform well, particularly when a central bank is lowering interest rates.
From 1980 through 2015, the U.S. economy experienced one of the most prolonged periods of disinflation in the country’s history. This occurred after the Great Inflation of the 1970s when prices increased more than 110%, and inflation reached 14.76% entering 1980, forcing the Federal Reserve to implement a monetary policy to reduce it.
What does all of this mean for the average consumer?
Depending on what type of an investor you are, deflation and disinflation could play a significant role in your financial and investment decision-making. Regardless of your investment strategy, having a diversified portfolio can help mitigate some of the risks involved in investing. However, there is no way to completely eliminate risk when investing in any security. When the economy is in the grips of deflation or disinflation, here are a few ideas to help make your money work for you:
Investment ideas during periods of deflation
- Consider looking into investing in dividend-paying stocks.
- Discuss High-Interest Savings Accounts (HISA) with your financial professional.
- Read up on Investment-grade (IG) bonds to determine if they are beneficial.
Investment ideas during periods of disinflation
- Consider researching investments that are sensitive to interest rates, like bonds. In the early 2000s during disinflation, the Fed lowered interest rates, which allowed bonds to generate above-average returns. Keep in mind that decent returns on past investments do not guarantee future results.
- Research assets with fixed cash flows like money market funds.
- Industries like manufacturing, transportation, and construction may not be as particularly strong during periods of disinflation.
Get the investment advice you need
It is important to remember that nearly all the well-known investors you study to learn about the market had mentors who guided them until they, themselves, became mentors. Make the time to consult your financial professional to learn how your financial decisions will impact you and align with your financial strategy and goals.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal and potential illiquidity of the investment in a falling market.
An investment in the Money Market Fund is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the Fund seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Fund.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by LPL Marketing Solutions
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