Deflation vs Inflation, and Our Changed Long-Run "Policy Allocation"

The mother of all questions: will deflation or inflation be the major U.S. and global trend in the next 5, 10 and 20 years? Having the right calls will lead some investors to drastically outperform others, save their investments from ruin, and live far more comfortably. (For example, investors who saw the '00s inflationary trend coming multiplied their net-worth many times over, while deflationary worry-worts saw their investments decrease in value. Investors who saw the declines in inflation coming this year made money in treasuries instead of losing enormous sums in equities.)

The question of deflation-or-inflation has become super-heated. The world's central banks and government treasuries fear economic crisis and deflation and thus are putting trillions of currency units into circulation. Meanwhile, a growing contingent of economists and investors see the money-printing binge as massively inflationary within the next couple of years, despite the global deleveraging that is taking money out of the economy. One of the more successful (and famous) investors with the latter view is Jim Rogers; a quick summary of his views is here.

We think the answer is worse than the question: We expect moderate deflation for the next year or two, and then a shift toward inflation as the lag-effect of the current monetary stimulus (which is likely to remain policy for too long) takes hold. In actuality, we see the market worrying most now about deflation while worrying a little bit now about inflation, and over the next year or two we expect the proportion of worry to shift toward inflation. There will be be many "watershed" moments along the way when inflation fears crystallize and U.S. government bonds sell off significantly owing to the inflation fears and concern about the implications of the $12 trillion U.S. debt, which could rise at about $1 trillion per year. We believe the resulting rise in interest rates as potentially the ultimate end to the U.S. consumer's power and its role in "global imbalances," which are today enabled by emerging economies' artificially low currencies.

What We're Doing:
(1) Adopting value investing disciplines that have been out of style since the early-mid-'80s. Compare dividend yields on asset classes and within asset classes, and gauge value in relation to long-run historical ratios. For instance, equities are still expensive around 3% yields, versus buying opportunities of 5-6% yields earlier in the 20th century. Trading equity momentum and P/E multiples will be difficult in the rolling bear/value market we expect for the next 5+ years.
(2) Raising long-run "policy allocation" of secure yield & cash equivalents to 30% from 10%.
(3) Raising trading allocation from traditional 5% of allocation to 10%. Use trading allocation to favor short positions.

Our long-run "policy allocation" now looks like this:
30% secure yield and cash equivalents
25% real estate (projected equity in our residence)
15% U.S. equities
15% emerging equities
5% treasuries
10% trading -- favoring short positions