Market Rallies on ---------Deflation worries?

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Amid Deflation Worries, Pros Turning to Long-Term Bonds
With investment advisers convinced the economy may be headed for a bout of deflation, they're turning to longer-term bonds for safety.


Key Points A deflationary environment has advisers looking toward longer-dated fixed income.Investors going longer even as inflation remains the longer-term worry.
The uncertainty of the current environment creates a complicated picture for investors, but many advisers continue to feel comfortable with the safety of bonds, particularly those from the US government and for a longer duration.

It's part of a mindset that believes inflation could well be the economy's long-term worry—going out two, three or four years from now—but in the near term prices could turn negative and bring about deflation.

"It's hard to see where the inflation is going to come from," says Brian Nick, investment strategist for Barclays Wealth in New York. "The longer-duration bonds look expensive but also look like stable, safe assets."



Nick recommends investors target 7- to 10-year durations in bonds and Treasury notes, though some strategists are even backing the 30-year long bond [US30YT=XX 4.0506 0.0626 (+1.57%) ].

Long-term bonds are a bad bet in an inflationary environment as their value erodes as costs go up.

But in deflation, they make attractive tools for investors who have the security of decent yields but also see increases in their face value and collect handsome coupon payments. Prices and yields move in opposite directions, with higher demand driving up prices and pushing down yields.

Government bonds had a remarkable July, with the yield on the benchmark 10-year note [US10YT=XX 2.95 0.045 (+1.55%) ] ending the month virtually unchanged even as the stock market roared higher by 7 percent. Stocks and bonds often move in opposite directions as risk dims the allure of safe-haven investments like government debt, so a stronger stock market would drive yields higher

Nick recommends a barbell strategy, with longer-dated US Treasury's on one end and triple-A rated sovereign notes from companies like Germany and Sweden on the other end. The middle would include investment-grade corporates, high-yield Treasures, convertible bonds and defensive stocks.

"Equities are going to be tough to pick individually in a declining market...You want to be in our opinion looking at higher-quality fixed-income," says Steve Baffico, senior managing director at Claymore Securities in Chicago. "That brings you to things like corporate bonds, asset-backed securities, even into the high-yield market, where there's a degree of undervaluation and some pretty high-quality product that's mispriced."

As with the question of whether the economy will enter a double-dip, the situation with deflation may be as much perception as reality.

Analysts say the economy may not actually meet the dictionary definition of a double-dip, though it will still feel like one. The same may be true for deflation, defined as a drop in prices often due to a decrease in money supply.

The Consumer Price Index has declined for three straight months but is up 1.1 percent for the 12-month period ended June 2010. And inflation slipped to 1.05 percent in June but trended above 2 percent for the preceding five months, according to the Bureau of Labor Statistics.

"A base case could be made for generally improving growth and moderate inflation. From an investment perspective, long-term assets such as long-term Treasury equities, corporate bonds and structured products are relatively attractively valued," says Robert Tipp, chief investment strategist at Prudential Fixed Income in Newark, N.J. "A diversified portfolio among these longer-term assets is going to offer some protection against deflation."

The story is changing that means that the FED wants to start unloading the massive amounts of bonds that it has bought. That also means that they are ready to pump up the money supply. I still maintain that Gold will be a casualty to prove that we are going to have a deflation. The St Louis Fed chairman made mention of deflation last week. The story is starting to go in that direction and Gold is acting weak.

They ran this story on a day where Oil was up 2.55, Bonds were down and the dollar got its butt kicked. I think their program is a little off.

Mikey