Mr. Bernanke spent his time last week in Wyoming discussing the Fed’s role in expanding the economy. One primary concern on the table currently is deflation rather than inflation. Remember in 2008 as the Fed and the US government poured trillions of dollars into stabilizing the economy the big fear was inflation from too much money supply. Thus far that has not been the problem. You have to have growth in order for inflation to become a problem. Last Friday Q2 GDP was revised lower from 2.4% growth to 1.6% growth. The trade gap was larger than expected and thus, less growth. The outlook from the Fed has shifted to fighting deflation.

CPI (Consumer Price Index) along with PPI (Producer Price Index) have shown little to no inflation all year. Why all the talk about inflation? Why is gold moving higher if inflation isn’t a concern? Why the sudden interest in deflation by the Fed? So many questions and so few answers relative to the future economic picture. The answer to all the question relative to this topic start and end with economic growth. There is a lack of clarity relative to growth in the economy which explains the volatility in the equity markets and it explains the flight to quality or bonds. Gold has become an alternative investment choice as well in avoidance to stocks. The global picture is similar with the exception of specific pockets of strength. There is a prevailing need assumed, stimulate growth at whatever cost. That thinking is what put us in the current situation economically. In the U.S. too much money supply following the 2000-2002 stock market collapse pushed money into technology stocks creating a bubble and collapse. This same money in 2003 started to moved toward real estate. The bubble started popping in 2006 and culminated in the banking collapse in 2007-2008. If we continue to push money at the problem we will create another bubble in another sector of the markets. Why? Money rotates to where the fastest growth is offered until there is no fundamental reason to own the sector. It is then followed by a collapse or money being withdrawn and looking for the next opportunity. 

Taking this into account, are bonds the next bubble being created? If you look at a chart of the 10 year Treasury yield you might say yes. If you look at a chart of the Treasury bond ETFs you might say yes. This is reason enough to take the necessary precautions relative to your bond holdings. IEF, iShares Barclays 7-10 Year Treasury Bond ETF has moved from $89.30 in March to $98.55 currently. The last time the ETF was at this level was the height of the financial crisis in December of 2008. The flight to quality then was rational and justified. Today, only time will tell, with hindsight, if the level is justified. At this point however, you have to evaluate the elevated levels in price to equate to an elevated level of risk in holding these assets. I am not saying to run out and sell your Treasury bonds, but establishing a stop, hedge or exit point would be a prudent approach.

Corporate bonds are in a similar boat, but they have leveled off over the last 3-4 months. They still offer some opportunities, but they will track the direction of the broader stock market indexes relative to trend. The fixed income market posses more risk currently in may ways than specific sectors of the markets. Money flow has picked up to dividend producing stocks and that brings DVY, iShares Select Dividend Index ETF into play. The focus of the ETF is to buy the top dividend paying stocks based on the Dow Jones Dividend Index. I would place this on a watch list and look for the opportunities as we move forward. The fund currently pays a 3.8% dividend.

Moving full circle the issues facing investors relative to inflation or deflation is leaning towards the deflation side. The Fed is on the case and they are determined to do whatever they can to keep the economy growing to curtail the risk of deflation. Our job is to manage our money relative to what we see on the horizon and for now that means risk in terms of deflation and risk relative to stocks moving lower. Taking a defensive posture is the best course of action relative to the data available.