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ETFs for Deflation

Also realize that the inverse ETFs deliver "double" the return of the market without leverage. For example, if the S&P 500 Index falls 5% in one day, SH should gain about 5%, good for 10% outperformance. If you are wrong in your timing, your losses will be just as large.

Inverse ETFs also reset daily and therefore suffer from compounding--and the volatility we've seen lately will only lead to even greater tracking error. However, for those who want to go short, ProShares Short S&P 500 (SH) is large and liquid, while ProShares Short MSCI EAFE (EFZ) and Short MSCI Emerging Markets ProShares (EUM) cover the international side.

Another option is a mutual fund such as the Federated Prudent Bear (BEARX) or Federated Market Opportunity (FMAAX), two funds I have used for some clients. Retail investors may face a 5.5% load on these funds, which is a major drawback, but if investors can buy them without fees they are solid options. Over the past three months, the S&P 500 Index fell 13%, while FMAAX gained 4.7% and BEARX gained 11.5%.

Just as inflation isn't a strategy in itself, neither is deflation. The U.S. could enjoy an extended bout of very low interest rates and very low inflation or mild deflation, even as the economy recovers.

Stocks could rise in that environment, and with dividend yields at attractive levels, a fund such as iShares Dow Jones Select Dividend Index (DVY) could best bonds. Technology may also perform well given the low debt levels of technology companies.

The best strategy for most investors is to hold a diversified portfolio of assets. Within that diversified portfolio, small changes in allocations and holdings can make a big difference. For instance, many investors may do better by reducing inflationary bets, rather than making specific deflationary bets.

-- Written by Don Dion in Williamstown, Mass.
At the time of publication, Dion Money Management was long iShares Barclays TIPS, iShares Comex Gold, iShares Dow Jones Select Index.

Don Dion is president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.

Dion also is publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.
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