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Earnings, Inflation, Deflation, Where Are
We?
by Troy Patton, CPA - Finance Geek
 Well you
have seen it on the T.V. just like I have said before.
Everyone is talking
about the new fear of deflation and what it means to our economy and our pocket
book. It may surprise you that a mild deflationary environment is actually good
and can create a great stock market performance.
As the chart above
indicates, the 31 periods since 1926 have created on average the best
performance in the markets. That is nothing to sneeze at. However, we must be
cautious as the chart also shows, massive deflation greater than –2.5% is a real
downer for the markets. However, the deflation we are facing currently, outside
of commodities, recently is very little.
We have to consider
the effect of commodities recent rise and now back to normal levels. The most
recent reported numbers excluding gas and energy, deflation is very mild. This
should bode well for the market. The biggest loser in a deflationary environment
will be the profits of the banks.
There is a happy
medium between deflation and inflation. Deflation keeps folks from consuming as
they think the price of something they may want to buy will get a little cheaper
if they wait. Inflation tells the consumer to not save as inflation will erode
their savings. Again, the best world is where consumption and savings are both
working in tandem.
(continued below)
 The
chart left shows the S&P Price to Earning ratios given specific deflation and
inflation levels. As you can see, the market trades at its best multiples given
low deflation and mild inflation.
This
should set the stage for a rally given current levels of earnings and mild
deflation. As we have said prior, we see this mild deflationary environment
followed by inflation that will near a 5% level as the government prints money
to get our way out of this mess. The printing presses will be humming. We need
to put everything in context today as the market is coming off one of the worst
performances it has had in a long while.
Let’s not
forget today’s environment is much different than the Great Depression. Among
many other things, today, the government is much more proactive with refund
checks, the TARP, and bailouts of industries. The other item we need to consider
is now folks receive Social Security checks. This was not the case in 1930!
(continued below)
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Once
again, there is no need to be scared of the prospects of mild deflation. As
prior history has indicated to us, it is a time when we can see the returns in
the market really recover some of the losses we have given up. The government is
going to take whatever steps necessary to keep us in this zone of mild deflation
followed by mild inflation.
The opinions written within this publications are
the opinions of Troy Patton and are not intended as investment advice or an
offer or solicitation to buy or sell any securities. If you would like to
contact Troy Patton, he can be reached directly at 800-671-5872
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