Americans of a certain age are used to worrying a great deal about inflation. They remember President Gerald Ford’s famous “Whip Inflation Now” speech back in 1974.
Other hawkish market pundits and economists, adherents of the Austrian School of Economics, are warning of impending inflation from the US Federal Reserve’s expansionary monetary policies.
Real risk
In my opinion, deflation is the real risk to investors.
Deflation is hard to get one’s hands around when all of our financial lives we have been living with varying degrees of inflation.
We expect prices to rise—although hopefully gradually—and to be able to receive more for the assets we have purchased like our homes and valuables.
Commodity bust
During bouts of deflation prices drop. In 2014, we are all well aware of the price of oil dropping 45%. This isn’t a decline it was a crash in the price of oil. Gold prices have declined from the 2011 high.
Recent inflation numbers from the Department of Labor, subtracting volatile food and energy, showed an unchanged price index in December, 2014, after a 0.2% increase in October, 2014, and a 0.1% increase in November, 2014.
Meanwhile Europe is sinking further into deflation and the dollar is hitting record highs.
In Switzerland the overwhelming strength of the Swiss Franc forced the Swiss National Bank to un-peg its currency from the Euro and to initiate negative interest rates.
Economic distortions
Deflation creates an Alice in Wonderland reality where banks offer to pay you to borrow from them.
Meanwhile, a conservative shift in the United States has led to a rapid decrease in government spending as State Houses and Congress manage to either cut services or obstruct stimulus spending as Government Austerity is implemented with fiscal austerity threatening the American econ
Bond dynamics
So what is an investor to do?
In an inflationary environment bond interest rates rise and the price of bonds dip as yields adjust to market pressure. Similarly deflation can cause interest rates to decline and the price of bonds to climb.
Some have argued that gold is a good hedge against deflation. After all shouldn’t people run to gold when a deflation panic ensues?
However, gold acts as a universal currency, the price of which depends on one’s own currency. In the US, the dollar has climbed this past year just as the price of gold has fallen.
In my opinion, gold works best as a hedge against inflation when your currency is falling, not rising.
Apple hedge
Apple (AAPL), on the other hand, is both a value stock and a dividend stock. In my opinion, secure dividend stocks can act as bonds.
According to Yahoo Finance Key Statistics, Apple has a $1.88 forward dividend rate, well-covered with only a 25% payout ratio.
The stock has a trailing P/E of only 16.19 and has a PEG ratio of only 1.09 suggesting that future growth is likely to reduce the already low P/E.
Firepower
According to Morningstar, Apple has $73.2 billion of current assets and only $43.6 billion in current liabilities.
It is well known that Apple is a cash machine and actually generated $49.9 billion in free cash flow in the 12 months ending September, 2014. And the company continues to have amazing financial results.
Currently (2/4/15) the ten year Treasury Bond yield is 1.794%. Interestingly, AAPL yields 1.6%. The Stock Chart (from StockCharts.com) shows a compelling Apple stock price performance since 2013.
Strong growth
Unlike a bond which generally has a fixed coupon return, Apple’s growth can allow it to increase its payout without making much of a dent in its growing pile of cash.
With its dividend competitive with the Treasury Bond 10 year yield, and its valuation reasonable with anticipated earnings and revenue growth and the upcoming Apple Watch soon to debut, and the unbelievable cash hoard, this tech stock may well represent an excellent deflation hedge.
In a deflationary environment cash is king while debt is a burden as one pays back debt in ever more expensive units of currency.
Even if deflation doesn’t hit the United States or we bypass most of that risk, Apple is a justifiable purchase anyhow in my view.
But if deflation does come, we may well find the stock price increasing as the dividend and cash are valued more dearly and Apple stock as a deflation hedge as good as any bond.
Photo Credit: Christopher Chan via Flickr Creative Commons
DISCLAIMER: The investments discussed are held in client accounts as of January 31, 2014. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.
