I was doing some research, and suspect the global economy might be heading into a disinflationary state. Lets assume this is correct, how would you rank the sectors in terms of attractiveness? Here is my ranking of the ten sectors: 1) Discretionary - consumers buy more 2) Healthcare - baby boomers more likely to seek out expensive, higher-profit health-care 3) Industrials - lower input costs 4) Staples - lower input costs 5) Telecom - cheaper services 6) Utilities - cheaper services 7) Financials - hardly affected 8) Technology - doesn’t benefit much from lower inputs, pricing suffers 9) Energy - lower pricing 10) Materials - lower pricing
"1) Discretionary - consumers buy more " - You got it backwards “7) Financials - hardly affected ?” - Hardly the case
Do explain cfa_gremlin why I’m wrong on discretionary and financials.
discretionary-in an inflationary state their dollars are going to be worth less tomorrow than today, so they will buy things today with those dollars. Reverse it for a disinflationary state. The money will be “appreciating”, so consumers would hold the money rather than spend it. Just my take…
In a disinflationary environment, assuming we get one, discretionary goods go down in price, but people also save more because real rates go up. Additionally, unemployment goes up and hence less money is available for discretionary goods. People don’t want to borrow as much in a disinflationary environment because there is a real cost to being in debt if real rates are positive. Better to save. In an inflationary environment where there are very low real rates or even negative real rates, it makes sense to be in debt for investment purposes because the opportunity cost of saving is very low or negative. Also, as monetary inflation increases, money supply must be growing; therefore, there is a good chance that the investment you bought is going to appreciate in value in excess of your cost of debt. Unfortunately, in the recent residential investment euphoria, people thought that credit expansion is perpetual, thus housing prices would continue to increase infinitely. What they forgot is debt can’t expand faster than the income used to service it. Financials business model is built on expansion of credit. They are big losers in a disinflationary spiral. I would put discretionary and financials as #10 with technology not too far behind.
“Picco” you are almost right. On a deflationary environment, prices are going down and the economy is slowing. Consumer discretionary will go down beacuse people cannot afford expensive things (restaurants, leisure etc) and consumer staples will go up. (prices are lower and people always have to spend money on food, etc). Same thing for heathcare. Those are defensive play. People will always need medicines etc. Financials will be the hit hard along with energy and materials. Most likely rates will be be lower (vs an inflationary environment), and financials will earn less on their investments. Somebody proves me wrong.
Something is strange here. If there is deflation, things on average get cheaper. So you still have to buy food and staples, but it costs you less. Therefore revenues go down because if they’re selling the same amount, but they’re cheaper, you don’t make as much money. So where is the profit coming from? If the company has debt, thats even worse, because the debt payments aren’t coming down with deflation. Things like leisure is harder for me to figure out. On the one hand, if you have more cash left over after your staple expenses, maybe you’d like to spend it on some leisure. On the other hand, if companies are going bankrupt because they can’t raise capital and unemployment is high, maybe you want to save your cash to make it last as long as possible. My guess is that super luxury stuff is good, because people who have tons of cash will take advantage, but medium priced stuff will suffer, since their clients might be scared for the future. Deflation is comparatively rare in history - very tricky to think through what the right bets are. But I would like to hear how this thread plays out.
What are you talking about…??? Deflation=prices drops from peaks and economy is gettin worst. Food companies have lower cost, people still need to buy basic stuff. Consumer staples will have higher margins, profits. If the economy is bad, people in general will save more then they spend, because they will expect though times ahead. So consumer discretionary will have lower profit and margin. Less luxury, restaurants and leisure.
So is this discussion about deflation or disinflation?
mik82 Wrote: ------------------------------------------------------- > What are you talking about…??? > > Deflation=prices drops from peaks and economy is > gettin worst. Food companies have lower cost, > people still need to buy basic stuff. Consumer > staples will have higher margins, profits. First, deflation is average price levels dropping from peaks, so that having cash is good because it will buy more tomorrow than it buys today. Economy getting worse is potentially a consequence - it’s not guaranteed. The fear is usually that since cash will buy more and more over time, there is no great incentive to invest it. Companies then can’t raise capital and start shutting down. That’s bad for employment, among other things. Now, consumer staples: people still need to buy basic stuff, true, but less money flows into the companies selling them. If we assume that the quantities of food stay more or less constant, that means revenues decline over time. Now it’s true that costs of supplying food might go down too, but there’s no guarantee that they are going to go down faster than the price of food, since the demand for things that make food is likely to be as inelastic as food itself. If they don’t, margins will decline. If they do, then you might see some cash profits, but these are less likely to be reinvested because holding cash is good. > If the economy is bad, people in general will save > more then they spend, because they will expect > though times ahead. So consumer discretionary will > have lower profit and margin. Less luxury, > restaurants and leisure. My point here was that there is a class of ultra-rich who probably aren’t affected much… so luxuries might actually do better than ordinary consumer discretionary. These people are finding it less expensive to pay for the other things in their life and therefore spend even more on luxuries. Then there are the vast majority of folks who are - as you say - worried about the future and investing in mattresses where they can store their cash.
The subject of deflation fascinates me. Anyone knows any literature talking about it?
Yes the CFA books
I’ve passed all 3 levels of the program and don’t remember reading anything extensive about deflation. The differing opinions in this thread makes me believe I’m not the only one.
Biggest thing I remember about deflation in the readings is that you have to reverse your preferences of LIFO vs FIFO.
There is also the possibility of shorting stocks?
deflation mongering again!. the US had consistent deflation between 1870 and 1896 and still had a real growth of around 4% .the US was an emerging economy then (ref Milton friedman and anna schwartz). deflation is not always bad. inflation is mostly bad,except in the early stages. this is a great read about inflation - book by Jens O Parssons http://www.amazon.com/Dying-Money-Lessons-American-Inflations/dp/0914688014
brilliant quote from Parsson’s book “Everyone loves an early inflation. The effects at the beginning of inflation are all good. There is steepened money expansion, rising government spending, increased government budget deficits, booming stock markets, and spectacular general prosperity, all in the midst of temporarily stable prices. Everyone benefits, and no one pays. That is the early part of the cycle. In the later inflation, on the other hand, the effects are all bad. The government may steadily increase the money inflation in order to stave off the latter effects, but the latter effects patiently wait. In the terminal inflation, there is faltering prosperity, tightness of money, falling stock markets, rising taxes, still larger government deficits, and still roaring money expansion, now accompanied by soaring prices and an ineffectiveness of all traditional remedies. Everyone pays and no one benefits. That is the full cycle of every inflation.”