I’ve been doing some research on which sectors perform best under deflationary conditions.
Obviously, cash is first and foremost as it will generate a natural real return over time without having to do anything, plus the nominal return you get from parking it in short-term funds (the Bank of Canada short-term rate right now is 1%).
Long-term bonds of solvent entities also are a good investment during deflationary conditions.
However, on the equity side things are a little more muted. The only direct play which I know explicitly has taken a position on deflation is the Canadian equivalent of Berkshire Hathaway, Fairfax Financial (TSX: FFH). Prem Watsa was fairly early to the subprime mortgage crisis in the USA but was able to profit handsomely on it, and he seems to be early on the deflationary game as well. His company has also been significantly short on S&P 500 equity index futures which also resulted in their portfolio performance suffering losses they really shouldn’t have been suffering. So while Watsa is likely paranoid, inevitably if you believe deflation is going to hit the marketplace and still need some form of equity exposure coupled with fairly competent management in asset allocation, then Fairfax is probably a good meal ticket. Regrettably, it is trading a shade over book value and historically it gyrates around it so there is likely a better opportunity in terms of market timing.
Interestingly enough, Watsa was also quite early in accumulating his (via FFH) 10% stake in Blackberry (TSX: BB). It remains to be seen whether this will be a win for him.