The Fed has chosen to use all of its might to fight deflation now. Of course, the side effect will be battling against high inflation in the future. However, this is the right thing to do.



Inflation can be controlled by making it harder to spend money. Interest rates can be raised and the supply of money can be cut off. The measures are painful, but the battle can be won.





Deflation is far nastier. Consumers who think a product will be cheaper tomorrow will hold off buying it today. Once people get in the habit of not spending, it is hard to get them to start again. Furthermore, the inability to raise prices hurts corporate earnings and limits wage increases. Deflation then becomes a self-fulfilling prophecy that lingers for an extended period of time.



We are seeing the effects of deflation in holiday shopping patterns. Consumers waited through all of November to shop on Black Friday. They have since cut back on their spending. Retailers, on the other hand, are having sales nearly every single day - yet the promotions seem ineffective.



And why should they be effective? I’ve been meaning to shop for a new suit for several weeks. Jos A Bank (JOSB) constantly sends me emails touting discounts that supposedly only exist for a few a days. I wait. The same discount appears again. Is there any reason for me to be motivated to act now? Not really, other than the fact that I could use a new suit.



The bigger problem facing the economy right now isn’t motivation, but rather a lack of access to credit. News reports, such as this one from NPR, suggest that creditors are seeking scores of at least 750-780. The average American has a credit score below 680.



When you add in higher interest rates, lower credit limits and job losses, it is easy to see why America has a spending problem. Or, I should say, a lack-of-spending problem.



Numerous interest rate cuts by the Fed have not helped, because lenders don’t trust borrowers. Until this changes, no amount of liquidity is going to help the U.S. avoid deflation.



TARP was supposed to unfreeze the credit markets. It hasn’t. In fact, no one is really sure what the money is being used for. Sadly, as Robert Reich recently said in his blog, \"The dictionary meaning of a ’tarp’ is something used to cover things up, which is exactly what we’ve got.\"



For investors, deflation means lower earnings growth and lower returns on investments. My advice is to keep your expectations for the stock markets low and hope that we all end up being pleasantly surprised.

Zacks Elite Portfolios



No changes to the portfolios this week. I loathed adding anything right before the Fed meeting because the response is always difficult to determine.



There are a few new candidates under consideration. If we add anything before the end of the year, it will probably be early next week,

The Markets



The rally in treasuries continued this week. Stocks were on the rise, but tripped up on Thursday. Options and futures contracts expire today, Dec 19, and quadruple witching always has the potential to make market direction a bit whacky.



Nonetheless, it seems like there are a lot of stock investors ignoring the massive flight to safety that is occurring in the bond markets. As I said last week, sustainable rallies in the stock markets do not occur when the credit markets are not functioning.



Stay Invested in Stocks

Despite my bearish tone, I continue to like the long-term outlook for stocks. Equities remain the best investment vehicle for building long-term wealth. Use the portfolios on Zacks Elite for stock ideas and dollar-cost averaging into fundamentally-sound companies that are trading at reasonable valuations.