Things can only get better (maybe)?

What if neither one wins?

Well, it IS a possibility. I've used the picture above to refer to the two monsters which threaten our future - the ongoing battle between inflation and deflation (with deflation emerging as the clear winner since last September). But, governments throughout most of the world have been doing their best to reflate, the latest and most significant being Obama's $819B stimulus currently working its way though Congress.

While some details may be changed, there is no realistic prospect of the new President's "big idea" NOT going ahead. And, however much I tend towards pessimism on this blog, I must admit to the possibility of it working, at least to a limited extent. Consider the current state of the Credit Crunch Investor Portfolio:

Ultrashort Lehman 20+ Year Treasury (TBT.AMEX)
A play on rising inflation forcing higher T-Bond yields.

iShares MSCI Singapore Index Fund (EWS.NYSE)
A play on an end to deflation and return to economic growth (mild inflation).

Lyxor Gold Bullion Securities (GBS.LSE)
A play on rising inflation and a loss of faith in other financial instruments.

Market Vectors Gold Miners ETF (GDX.NYSE)
A play on rising inflation causing the gold price to increase faster than mining costs.

Centamin Egypt (CEY.LSE)
A play on rising inflation causing rising gold demand, forcing gold producers to buy new projects.

iShares Euro Government Bond 15-30 (IBGL.LSE)
A play on continued deflation forcing down ECB short-term interest rates.

M&G International Sovereign Bond Fund
A play on continued deflation increasing the value of government debt (and on sterling weakness).

CurrencyShares Japanese Yen Trust (FXY.NYSE)
A play on continued deflation causing the real value of cash to rise (and the BoY being reluctant to print money).

Lots of cash in GBP and USD
A play on continued deflation causing the real value of cash to rise.

Broadly,then, I have four investments that will do well under inflationary conditions, four (including cash) that will do well under deflation, and only one (EWS) that will do well if "things" (i.e., the global economy) actually get better, without sparking high inflation.

Now, don't get me wrong, I'm still bearish. I do think that this is the big one, a second Great Depression which will only be "cured" by massive debt liquidation and very high inflation rates. But, at least for the next few months, I am warming to the idea of a bit of a bounce. Are there assets out there which could prove profitable if the world economy just "does ok" (or, at least, doesn't get much worse) for a few months?

A great bit of reading is published yearly by Barrons Magazine - their January Roundtable of investment experts, pitching their ideas for the year ahead. Of course, if you're a tightwad like me, you won't want to shell out for the mag itself, but luckily the articles (it's in three parts) have been republished on the web. Check out the following links:

Part 1 - Meryl Witmer and Fred Hickey

Part 2 - Bill Gross, Felix Zulauf, Archie MacAllaster and Abby Cohen

Part 3 - Scott Black, Marc Faber, Mario Gabelli and Oscar Schafer

Now, there's lots of good ideas there, but one theme that jumped out at me was the spread between US Treasuries and corporate debt, especially sub-investment grade corporate debt (or, to put it more plainly, junk bonds). Bill Gross, the Pimco bond expert, points out that (at the time of the session) the Pimco High Income Fund was yielding some 23%, yet only 40% of its holdings were actually high-yield (i.e., 60% investment grade). Marc Faber discusses the Nicholas-Applegate Convertible and Income Fund, which also has a yield in the 20% range.

I am intrigued. A 20% yield is something quite exceptional, when interest rates are heading for zero world-wide. Obviously, it signals that the market thinks such dividends are unsustainable, or that they are necessary to compensate to the risk of high inflation. But, suppose the market is wrong? Suppose that things actually get a little better ... for a while at least. There must be a mass of income-hungry investors who would like a crack at these yields. Further investigation required!