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What would deflation mean for your ASX shares?

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Deflation can strike fear into the hearts of ASX share investors. 

Deflation can eat away at profits and drive real returns lower. However, there are certain industries that may do better than others in a deflationary setting.

According to an article in the Australian Financial Review (AFR), now could be the time to start looking at those options.

The impact of deflation across industries

Westpac Banking Corp (ASX: WBC) is forecasting a record-breaking 2.4% decline in the June quarter CPI to be released today.

Deflation may set off warning bells for many investors. Given benchmark interest rates are affected by inflation figures, deflation could lower rates and impact returns on many loans, leases and other contracts.

However, the nuts and bolts of legal documents may save the day.

For starters, many landlords and other businesses have reference rates that include a floor at 0%. That means real estate groups like Mirvac Group (ASX: MGR) may weather any deflationary storm.

But it’s not just landlords and real estate moguls that may be protected. Industries that receive strong support through government contracts might also benefit.

One such industry involves toll roads, meaning ASX shares like Transurban Group (ASX: TCL) may do better than expected.

Long-term government contracts often have scheduled payment escalations, and that means current deflation will make those relative payment increases even more valuable.

How can I take advantage of deflation with ASX shares?

In theory, deflation should lower the price of general goods in the economy, which means earnings for consumer discretionary shares like Coles Group Ltd (ASX: COL) could take a hit.

Part of the reason for the forecast deflation is due to a short drop in fuel prices, and this could help industries that benefit from lower fuel costs. Normally that would be the travel sector, but thanks to coronavirus that’s no longer the case.

I would look at companies in the manufacturing sector that benefit from cheaper energy. A big-name manufacturer like Brambles Limited (ASX: BXB) could be in the buy zone.

I also think the healthcare sector could benefit due to its non-discretionary earnings.

Healthcare prices aren’t really correlated to the general price of goods and services. Therefore, an ASX healthcare provider like Ramsay Health Care Limited (ASX: RHC) could be worth a look to protect your portfolio against deflation.

Foolish takeaway

Investing in ASX shares to fight inflation can be good for diversification and overall return.

However, you may also open yourself up to other potential issues like currency or company risk.

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Motley Fool contributor Ken Hall has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of COLESGROUP DEF SET and Transurban Group. The Motley Fool Australia has recommended Ramsay Health Care Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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