Final answer:
During deflation, cash and bonds typically show high returns due to increased purchasing power and the value of fixed incomes, while equity and real estate have low returns due to declining prices and profits. Additionally, real estate is hindered by its low liquidity, making it difficult to quickly convert properties into cash and realize capital gains.
Step-by-step explanation:
When considering asset class returns during deflation, the performance of various asset classes such as cash, bonds, equity, and real estate can differ. In a deflationary environment, the value of cash typically increases because the purchasing power of money grows as prices decrease. Cash holdings tend to show high returns in terms of increased purchasing power during deflation. On the other hand, bonds also often perform well because the fixed income they provide becomes more valuable as prices fall, assuming the issuer's creditworthiness remains solid.
Conversely, equity returns are usually low during deflation because company profits can decline due to falling prices and reduced consumer spending. This can lead to a decrease in stock prices. Real estate similarly experiences lower returns, as the price of property typically drops in a deflationary environment, and the low liquidity associated with tangible assets, such as real estate, makes it difficult to sell property and realize capital gains.
Understanding these general trends helps investors navigate asset allocation decisions during periods of deflation, keeping in mind the specific context and market conditions at the time. Moreover, navigating through a deflation requires a solid assessment of one's investment risk tolerance and liquidity needs.