The global financial meltdown has led to various governments across the globe into pumping billions of dollars into the economy to revive demand and growth in the economy. Increased money supply does help in pushing the demand for goods and services up thereby helping the economy grow . There are green shoots of recovery already in some parts of the world. India and China are already growing at a healthy rate. One of the bad effects of de-growth and recession is the menace of deflation. India is already in deflation officially. Deflation is potentially very dangerous to the economy and can lead to serious damages on the demand side in the economy.But we need not worry too much about it because of 2 reasons . First reason is that in India even though the WPI is in negative the CPI is still at 9% , which is very high. So technically the demand for essential items like food articles etc is still on the rise. The second reason is the deflation is expected to be a short lived phenomenon. This is because, the large scale pumping of money into the system will create excess liquidity in the system , which will eventually lead to inflation.
Inflation is a double edged sword , while it provides an opportunity for an appreciation in assets , it also pushes the purchasing power of money lower. With the likelihood of inflation making a grand comeback , how should you be approaching your investment strategy. Well there are few asset classes which do well in an inflationary economy and as such you must look at these asset class right now to benefit when the inflation returns.
1. STOCKS - There is a direct relationship between the money supply in the economy and the stock market gains. Whenever there is excess liquidity in the market, the stocks prices go up. The bull run of 2002-2008 was primarily driven by the excess liquidity and cheap credit world over, and the recent bear market started when the liquidity dried up from the market post Lehman Brothers fiasco. So, when inflation returns back, chances are that the stock market will go up again. It already has gone up by 50%-80% . It might go up more in coming 12-24 months. Mr. Rakesh Jhunjhunwala has predicted that Nifty might touch 6000 by 2009 . Another famous broking house has predicted that BSE will trade at 30000 in next 3 years. So,chances are that stock markets will give more than average returns when the inflation returns back. Investing in stock markets now will help book handsome profits during the days of healthy inflation. Word of caution on stock investing is that you must invest in stocks depending on its value,price fundamentals etc. Do not invest indiscriminately in stocks.
2. SHORT TERM BONDS - Bonds are a good investment when the inflation is low since the impact on the yield is not much . But one must stay away from investing in bonds for a longer maturity period , if one expects inflation in future. This is because inflation will push up the interest rates and any increase in the interest rate will pull the yield on the bond maturity down. So your gains from the investment in bonds will be lower. As such since inflation is at an all time low these days, you must invest in bonds for shorter duration. Use the ladder approach, where you can reinvest the maturity proceeds again in bonds at a higher coupon rate.
3. COMMODITIES - Inflation pushes the prices of commodities higher. And any investment made in commodities now, is very likely to fetch handsome returns when the inflation inches northwards . One can look at investing in commodities like gold,silver, copper etc now when the prices are muted. My suggestion would be to invest about 15-25% of your investible corpus in a mix of commodities comprising gold, silver, copper,cotton etc. Stay away from betting just on 1 or 2 commodity. Investing in the shares /stocks of commodity based companies will also be beneficial.
4. REAL ESTATE - Another asset class which benefits from rising prices or inflation is real estate. The surge in real estate prices during 2003-08 is a testimony to the fact that when inflation is higher, the prices of buildings,plots,flats etc zoom up. People made lot of money in real estate during those days. Now the prices have come down, but are expected to head north once again. hence anyone looking to invest in real estate, should do it now since the prices are lower and aslo the interest rate on home loans are lower. Both these will rise once again . Real estate is an evergreen investment which grows in value over a period of time. It fetches more returns during inflation.
The above mentioned are few of the assets where one can invest now, to reap the benefits of capital appreciation when Mr. Inflation makes grand comeback. And inflation will come back . According to the RBI's estimate, the inflation in expected to be 5% by March 2010 from the current level of -1.14%. So, get your portfolio right so that it stays healthy for you in face of inflation as well.