Deflation is in the air, Putnam investment chief says

Inflation is no longer the nation’s chief economic problem; it is deflation, according to Jeffrey L. Knight, deputy head of investments and chief investment officer at Putnam Investments of Boston.

“We have to stick with the current evidence that commodity prices are falling, and falling fast,” he said as a panel participant at NAVA Inc.’s annual conference in Philadelphia last week.

“The value of any paper assets is being called into question,” Mr. Knight added, noting that investors in search of balance in their portfolios might want to look at precious metals and high-quality government bonds. “I think for the foreseeable future, inflation is the least of our concerns.”

The low yields on Treasury securities make them unattractive at the moment, and mortgage-backed securities — while “considerably underpriced” — may drop still further, Mr. Knight said.

Other panelists at Reston, Va.-based NAVA’s conference pointed out the danger in looking for investment bargains, particularly in the financial sector.

“[Investors] are using their traditional valuation models while going through a financial crisis,” said Lincoln Anderson, chief investment officer and chief economist at LPL Financial of Boston, who took part in the same panel discussion as Mr. Knight: “Economic Change — Is Slow Growth Here to Stay?”

“You want to tell them to stop doing that,” he said. “You’re in the middle of a crisis, and they’re overweighting into these cheap financials.”

But bonds have proved a good alternative to battered equities, Mr. Anderson said, as they don’t seesaw as much as their stock counterparts.

“I would have loved to ramp up our bond exposure six months ago,” he said.

“With fixed income, you don’t have these super-fast moves in response to information,” Mr. Anderson said. “There’s some time, and the market doesn’t rally 20% or 30% in one week.”

That bit of advice resonates with Steven Sheldon, principal and portfolio manager at SMS Capital Management LLC, who thinks that corporate bonds look promising.

“Given the economic uncertainty, everyone is freaking out,” he said. “Despite potential for increasing credit risk, corporate bonds offer a good deal.”

Intermediate-term investment-grade corporate bonds provide a good alternative as stockholders in financials get hosed.

Yields have been coming in at 6.5% to 7%, a good return without equity exposure, Mr. Sheldon said.

Charlotte, N.C.-based Bank of America Corp.’s $10 billion stock offering “is going to hurt those stockholders, but it will benefit the bondholders,” said Mr. Sheldon, whose Bellaire, Texas-based firm manages about $30 million.

“The pendulum should be shifting to the bondholders in the next three to six months while the financials look to repair their balance sheets,” he said.

Metals might make sense in an environment that goes deflationary, Mr. Sheldon said. Gold might have even farther to fall and could be “decent” if it’s cheap enough, but for now, SMS is merely watching commodities before deciding to build positions in such funds, he said.

STAY THE COURSE

Still, some financial advisers are opting to roll along with the market without searching for bargain assets — even if rattled clients become fixated on short-term returns, or a lack thereof.

“We’re big believers in market efficiency,” said Charles Massimo, president of CJM Fiscal Management. His firm, which practices passive management and is based in Melville, N.Y., manages $120 million.

Nervous clients, once focused on staying the course, need to be reminded amid recent market difficulty that diversification and re-balancing won’t buffer them entirely from volatility, but it will make sure that they are still on track to meet long-term needs.

As a result, Mr. Massimo said the firm has been inundated with calls, and the adviser has had to remind clients of all they stand to lose if they decide to jump out of their current allocation and into something more exotic.

“If you can time the market, figure out when to be in precious metals and get it right for one year out of 30, then you’re good,” he said. “But the rest of us just can’t time the markets, and as difficult as it is, that is the advice that pans out.”

E-mail Darla Mercado at [email protected].

Related Topics: E*Trade Financial Corp.