Last month I wrote a piece about how a period of high inflation would affect your ASX shares. Today, we'll consider the exact opposite.
Deflation (or negative inflation) is a term that you don't hear too often in investing circles. It's a problem the Australian economy hasn't had to deal with in living memory. But deflation has reared its ugly head in other countries. Japan, for instance, has been struggling with deflation in some form since the early 1990s. Some countries in Europe have also had it on their radar.
But it's something that the Reserve Bank of Australia (RBA) is worried about for our own economy. These fears partly explain why interest rates are at record lows and the RBA is watching the inflation rate like a hawk (or perhaps a dove).
What is deflation?
Deflation is the opposite of inflation – that is, rising prices. Falling prices might sound like a good thing, but you might change your mind if it was accompanied by falling wages (which it normally is). Deflation has terrible effects on the economy as well. People don't tend to spend money (let alone borrow it or put it in the bank) if they think it will be worth more tomorrow.
As more and more people cut back spending, it exacerbates deflationary pressure. No wonder the RBA is pulling out all the stops to avoid this situation.
What would deflation mean for ASX shares?
As you might have gathered, deflation is also bad news for share markets and the ASX would be no exception. People not spending money means that companies aren't making money – hardly a recipe for high stock prices or dividend increases.
Japan's stock market – measured by the Nikkei 225 – has yet to break the all-time high that it set back in the early 1990s! That's over a quarter century of flat growth, which you can probably lay at the feet of persistent Japanese deflation.
Where would you invest in a deflationary environment?
So if deflation were to hit the Australian economy, I would be putting my investing eggs in the baskets of only a few companies. Consumer staples would be particularly appealing as we will still all have to eat and buy life essentials. Woolworths Group Ltd (ASX: WOW) or Coles Group Ltd (ASX: COL) come to mind.
Most people still enjoy a drink (or two) in all economic weather, so Treasury Wine Estates Ltd (ASX: TWE) might be a good bet as well. Diversified companies like Washington H. Soul Pattinson & Co Ltd (ASX: SOL) or even Stockland Corporation Ltd (ASX: SGP) would also be on my list.
Foolish takeaway
Those 1% term deposits don't seem too bad when you consider the deflationary environment that the RBA is staving off as an alternative. I'm not saying that deflation in Australia is likely any time soon, but I always like to consider all possibilities and ramifications for my own portfolio.
