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Colin McLean: investing through the coming deflationary shock

by Colin McLean on May 07, 2014 at 14:34

In the eurozone, however, it is hard for an individual member to break free from Germany’s deflationary policies. Inflation will stay low while Germany persists in running a current account surplus and does not recycle this into the periphery.

If nominal GDP falls, the debt burden will rise on a shrinking base. Wealth taxes, rather than a bailout of the banking sector, might be the only solution. Without a break-up of the eurozone, the ECB may need to be much more stimulative. 

The challenge for investors in assessing the risks is ‘availability bias’. Headlines remind us of a housing bubble, and it is difficult to reconcile this with the inflation indices.

Yet localised inflation in an asset class may not find its way into generalised inflation. It may even exacerbate deflationary pressures, as rising housing costs leave renters and borrowers with less spare cash.

Investors may have time to adjust.  Analysts are optimistic about the prospects for reflation and it may take time for a new environment to bite on company profitability. Before this happens, investors might do better to consider the likely policy response.

Analysts might be slow to factor in deflation but politicians know it could harm their chances of re-election. So an unprecedented policy response seems likely, which should benefit financial assets.

It is hard to boost the real economy without leakage into stock markets and property. Equities may not peak until governments and central banks run out of imaginative ways to stimulate.

Colin McLean is the founder of SVM asset Management and co-manager of the SVM UK Growth Fund

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