Based on the discussion in my previous article (visit my blog) on biflation for the next two years, I also see a potential drag on stock prices by margin squeeze with companies unable to pass through cost increases. In this presentation, I outlined this scenario with four investment strategies.

1. Prepare For The Coming
Stock Price Invasion
Dian L. Chu, June 2010
Economic Forecasts & Opinions

2. Executive Summary
 Macro Environment – From Biflation to a tale of
two inflations – Hyperinflation & Stagflation
 Employment & Wage – Meager growth next
two years
 Stock Price Invasion – Expect a margin
squeeze to put a drag on stock prices as
companies are unable to pass through the cost
increase from the raw material side
 Four Investment Strategies
By Dian L. Chu, June 2010 2

3. Europe Debt Crisis Deepened
in 2010
Chart Source: The Economist & CFR
By Dian L. Chu, June 2010 3

4. Increasing Concerns of Deflation
 More pronounced in Europe as spending
cuts and tax increases could weigh on
economic growth and feed into deflation.
Chart Source: The Economist
By Dian L. Chu, June 2010 4

5. Slowing Inflation in the U.S.
 Consumer Prices were up 2.2% in May year-
over-year
 Core CPI was up just 0.9% in May, the smallest
increase since 1966.
By Dian L. Chu, June 2010 5

6. Goldman Consumer Price Index
 [Goldman Sachs Diffusion
Index] shows clearly that the
disinflation since mid-2008
has a considerable amount
of breadth.”
 “Consumer prices are falling
across a wide cross section
of the economy right now.”
~ Goldman Sachs
By Dian L. Chu, June 2010 6

7. Easing Inflation Expectation
 The TIPS market suggests
investors' longer-term
inflation expectations are
rising since hitting bottom in
Q4 2008.
 The implied annual inflation
rate over the next decade
now stood at around 2.03%,
rising from around 1.47% a
year ago, but down from
2.41% at the end of 2009.
By Dian L. Chu, June 2010 7

8. Plunging Money Supply
 The M3 money supply in the U.S. is contracting
at a rate matching the Great Depression, also
pointing to the risk of deflation
By Dian L. Chu, June 2010 8

9. Commodity Prices Shot Up
 The May core PPI for crude goods shot up 60%
year-over-year, the fastest rate since 1974. Including
energy and food costs, crude goods prices rose
21.2%.
Chart Source: U.S. BLS By Dian L. Chu, June 2010 9

10. Increasing Backlog
 Backlogs are rising uniformly worldwide
signaling more inflationary pressure in the
pipeline
ISM Manufacturing Backlogs ISM Manufacturing Backlogs
65 65
60 60
55 55
50 50
45 45
40 40
35 35
30 30
25 25
20 20
2005 2006 2007 2008 2009 2010 2005 2006 2007 2008 2009 2010
US Japan Eurozone China Brazil India
Source: IHS/Global Insight
By Dian L. Chu, June 2010 10

11. The Employment Malaise
 The jobless rate rose to 9.7% in May - Slow recovery from the 26-year
high of 10.1% in October 2009.
 The underemployment rate was 16.6% in May, still close to October’s
17.4%, a record high.
 “Wage growth in the U.S. will be meager – near 2% over next two
years.” ~ IHS/Global Insight
Chart Source: “World Economic Outlook”, Apr. 2010, IMF
By Dian L. Chu, June 2010 11

12. Consumer Confidence
 “Household confidence in
advanced economies
continues to lag,
reflecting subdued
employment.”
~ IMF
Source: “World Economic Outlook”, Apr. 2010, IMF
By Dian L. Chu, June 2010 12

13. Most Likely Scenario
 This could result in a
combination of:
 Pushback from end
markets are strong
enough to trigger price
corrections directly at
some of the overheated
commodity level
And
 Companies are forced to
absorb part or all of the
cost increases
depending on the
strength of end markets
By Dian L. Chu, June 2010 13

14. Biflation Through 2012
 Biflation - A state of the economy where inflation and deflation occur
simultaneously
 Pockets of inflation seen as money flowed into certain categories such
as energy and feedstock chemicals and deflation in other “non-
essential” categories
 Netted to a modest headline consumer inflation
By Dian L. Chu, June 2010 14

15. Bad News For Many Companies
 Raw material price increases
begin to move down the supply
chain, pushing up companies’
costs
 However, end markets are still too
weak to allow a full price increase
 Many companies say they are
reluctant to pass price increases to
consumers who are still jittery from
the recession
 Margin Squeeze– a drag on share Chart Source: WSJ.com
prices
By Dian L. Chu, June 2010 15

16. Asia Leading The Growth
 Real GDP growth picked up
starting in Q2 2009.
 However, output in most
regions of the world remains
below or around pre-crisis
levels
 The exception is emerging
Asia, which accounts for a
growing share of world
activity.
 Commodity prices have
rebounded in response to
expanding activity Source: “World Economic Outlook”, Apr. 2010, IMF
By Dian L. Chu, June 2010 16

17. 2013 - A Tale of Two Inflations
 Stagflation in developed
regions such as the U.S. and
Europe, where imported
higher inflation from the
emerging countries will likely
be met with stagnant growth.
 Hyperinflation in developing
and emerging economies due
to robust growth.
 Inflation in India already
reached above 10% in May, Source: “World Economic Outlook”, Apr. 2010, IMF
2010
By Dian L. Chu, June 2010 17

18. Investment Strategy # 1
 Commodities via physical
ETFs or mutual funds
 Natural gas, copper and
agriculture products look
relatively undervalued
right now
 Stocks and/or ETFs of
commodities producers
 Long term play – Crude
oil, oil products, and oil
producers
By Dian L. Chu, June 2010 18

19. Investment Strategy # 2
 Pare equity holdings with heavy
exposure in the U.S. and
European markets, particularly
the retail and consumer goods
sector.
 Invest in luxury brands with
good exposure to emerging
markets
 Drug and health care sectors
should still perform relatively
well regardless of regions
 Investors have poured $27
billion of net new money into
foreign equity funds this year,
while yanking $20 billion out of
U.S. equity portfolios.
By Dian L. Chu, June 2010 19

20. Investment Strategy # 3
 Gold shines in times of
inflation as well as
deflation
 3-5% of portfolio should
be allocated to gold and
other precious metals
via physical holdings
and/or physical ETFs
By Dian L. Chu, June 2010 20

21. Investment Strategy # 4
 Cash and mixture of ETFs and/or mutual funds
of short and long dated bonds and TIPS
 Real estate in the U.S. looks to have another
leg down in the 2nd half of this year – could be a
good long term opportunity in selected markets.
 Real estate market in China could have a
cooling off period with Beijing trying to prevent
asset bubbles – Could be good entry point in
the sector for a long term play
By Dian L. Chu, June 2010 21

22. Prepare For The Coming
Stock Price Invasion
Dian L. Chu, June 2010
Economic Forecasts & Opinions