The Road to Disinflation

I

n the last year and a half, the Federal Reserve has been fighting hard against the high inflationary costs that we've seen coming out of the pandemic. 

Price wise, everything has gone up. Our lifestyles, our utilities, our food and our gas are still at a 40-year high.

**Disclaimer: Remember, nothing I give to you is financial, legal, investment or tax advice, but here are my thoughts.**

The Federal Reserve has been raising interest rates and will continue to do so as an attempt to reduce demand, which would reduce consumption and bring prices down. So far, we're seeing some reduction in some costs, but many are still sky high.

But what about assets? How are assets affected by today’s market volatility?

Consumer Inflation vs Asset Deflation

While consumer prices are rising, assets/investment valuations are not. Financial market assets like on Wall Street, stocks and bonds, are in free fall.

What about real estate (my preference) and other tangible assets? Their valuations are coming down – just not as fast as in the financial markets. 

If you’re investing in the financial markets, it’s not clear what the best move is (other than to just get out – which would be my bias). I would personally be out of the financial markets. I don't study it and don’t want to. I don't try to play the games there. To me, it's just a casino.

What about real estate

Tangible assets give me, the retail investor, a lot more ability to be discerning – to pick and choose what I invest in. Does it take a little bit more work? Absolutely, it does. But the work is worth it for me to be able to choose between asset classes (equity or debt), between geography of investments, or whether I keep my money on the sidelines.

“Isn't leaving your money on the sidelines bad during times of inflation?”

Not necessarily, if you understand how market cycles function. Market cycles have been going on for forever. The turning of a cycle is usually accompanied by correction and (potentially) recession.

It's like a forest fire coming through and cleaning out all the underbrush so that the big trees can grow stronger. I believe this is what is happening and will continue to happen in 2023 or 2024 to some extent. So in times of forest fires (recessions) sometimes it’s best to keep your money out of the path of the fire. Then you can be ready for the opportunities and growth once it ends.

When do you buy back in?

In real estate, there is a lag time. If you stay in front of what's happening in terms of prices and market behaviors then you can know when it is the right time to go back in.

No matter what, I base everything on cash flow.

What's the cash flow? What am I getting as a return? And, What's the downside risk?

If I believe in the model (how they provide cash flow), I believe in the asset and in the demand for the asset. In real estate, I can choose the asset I want and be discerning about my choice, waiting for the right moment to buy back in.

If it has the cash flow I want (measured to my needs and or desire for growth) and provides as much protection to my principal as possible, then there may be a case to buy back in.

What about using leverage right now with potential disinflation? 

Leverage is one of the big benefits of investing in tangible assets like real estate or businesses.

However, right now is not a good time to use leverage. Interest rates are up and asset prices have not come down yet.

Again, there's a lag effect in real estate. It could take 12 or 18 months. In the last great recession, the downward trend of real estate took over 36 months to hit the valley of those prices.

You can't time it exactly right, but you can certainly have a clue as to when to stay clear and when to go back in. 

Warning to those who have not been through a FULL market cycle.

As an investor, be VERY careful right now. There's a lot of FOMO out there. There are many who are saying “You have to get into this now!” Granted, a lot of people have been making money hand over fist in the last 3-8 years but those days are over. The market has changed.

Asset deflation will create opportunities to buy back in when asset prices have corrected back to valuations which are based on market fundamentals – not speculation and hype. But we’re not there yet. 

 

Right now is the time to be patient. Patience is a virtue. Hold on, be discerning and wait for the time to buy back in.

To your freedom!

– David

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