The Big Hedge

Chidem Kurdas

Two opposed macro views have yet to be reconciled.  Many investors tend to go by one or the other. But others favor a meta-level hedge containing protection against both.

One view says the flood of money released by the Federal Reserve and other central banks since the crisis of 2008 will push up prices and interest rates. Inflation will rear up while policy makers are still trying to stimulate the economy. From this perspective, buying commodities, including gold, offers protection against coming inflation. For bonds, inflation is poison.

From the other standpoint, deflation is the greater danger because bad debts – in the United States, primarily mortgages – are still on the books and deleveraging will take more time, making for weak economies, prices and interest rates. Your best bet is to buy high-quality bonds. Hence the large inflows into fixed income funds.

Democrats tend to be deflationist, Republicans inflationist. But for investment purposes, better to prepare for both possibilities.

Interest rates are likely to remain low, says Jeremy Radcliffe, a managing director of Salient. Unwinding credit is inherently deflationary and between the debt overhang and unemployment, it is hard to see inflation as the real problem, he said. Treasury bonds, investors’ safe haven since the crisis, will stand up in an extreme deflationary scenario.

But for equities immediate prospects are dim if economic growth continues to be anemic for the next one to two years, as the Federal Reserve anticipated with its policy decision to keep rates exceptionally low through mid-2015. The stock market has been see-sawing, possibly because of the alternating influences of inflationary- versus deflationary-scenario investors.

Mr. Radcliffe argues against an asset class that has been popular, dividend-yielding blue-chip stocks. For the chance that inflation does show up, he recommends commodities. The combination of treasuries and commodities hedges both deflation and inflation.

Add credit strategies and you get better yield. That hotbed of hedgers, Goldman Sachs, says expect strong demand for corporate credit and further narrowing in spreads, suggesting a deflationary stance. But go for short duration just in case rates rise.

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