Stocks: Five Trends to Watch in 2009 (1)

By David Bogoslaw

With the U.S. government determined to throw virtually everything in its toolbox at the recession in hopes of minimizing the economic pain, it may be all but impossible to single out any one policy element that started the recovery rolling. Indeed, there are so many moving parts right now in the economy—though the public perception may be that Bernanke, Paulson & Co. are spinning their wheels instead of moving the wagon forward—that it's tempting for investors to throw up their hands and find a nice quiet place to hole up until the recovery comes.

But you might be missing some opportunities to protect your portfolio or make some money. And that requires keeping your ear to the ground. BusinessWeek asked economists and investment strategists to identify five trends that bear watching in 2009 and that could provide clues about how to position your investment portfolio.
Deflation vs. Inflation

Deflation clearly has the upper hand over inflation for the foreseeable future, and the Federal Reserve's decision on Dec. 16 to knock down the Fed funds rate to a record low of zero to 0.25% drives home that fighting deflation is now the central bank's priority.

What few people mention, however, is the potential benefits of deflation for U.S. consumers, starting with the plunge in energy costs and a discernible easing in interest rates. That may hurt people who thrive on investment income but it's more likely to spell relief for individuals who still have jobs and companies looking to borrow or who want to refinance existing mortgages or other debt, says Dan Peirce , portfolio manager in the global asset allocation group at State Street Global Advisors (STT) in Boston.

That suggests some of the battered sectors in the equities market such as retailers, restaurants, and apparel chains may be able to beat market expectations in 2009, he says. If that's your belief, Peirce points toward sector-oriented exchange-traded funds or mutual funds that focus on consumer staples or even consumer discretionary stocks. Peirce says investors should not be dissuaded by all the front-page headlines about the auto manufacturers, which are part of consumer discretionary group but account for a much smaller portion of the sector than they once did. Even some of the more diversified media companies that focus on advertising and broadcast operations may be good bets in light of the beating they have taken, he adds.

Some strategists will tell you that as long as the deflation risk outweighs the potential for serious inflation, the bond market offers more attractive returns than equities. The real (inflation-adjusted) yields on 10- and 20-year Treasury Inflation-Protected Securities, or TIPS, compared with the nominal yields of regular Treasury notes of comparable maturity suggest that inflation will be extraordinarily low over the next 10 to 20 years, says Peirce. While the TIPS market has already priced in expectations of hugely negative inflation over the next two years, Peirce says his group doubts it will be that severe.

Although inflation probably won't be a credible threat again until at least 2010, it will become a concern much sooner in the next expansion than it had been in each of the last three expansions, Dan Laufenberg, chief economist at Ameriprise Financial (AMP) in Minneapolis, predicted in a report published Dec. 19.

If inflation returns sooner than expected, the place to be is in equities with exposure to rising commodity or asset prices, including energy and steel producers, says Hank Herrmann, chief executive at Waddell & Reed (WDR). Reducing your portfolio's allocation to fixed income would also be a good idea since inflation would push yields higher and bond prices lower, he says.