Nick recommends investors target 7- to 10-year durations in bonds and Treasury notes, though some strategists are even backing the 30-year long bond.
Long-term bonds are a bad bet in an inflationary environment as their value erodes as costs go up.
But in deflation, they make attractive tools for investors who have the security of decent yields but also see increases in their face value and collect handsome coupon payments. Prices and yields move in opposite directions, with higher demand driving up prices and pushing down yields.
Government bonds had a remarkable July, with the yield on the benchmark 10-year note ending the month virtually unchanged even as the stock market roared higher by 7 percent. Stocks and bonds often move in opposite directions as risk dims the allure of safe-haven investments like government debt, so a stronger stock market would drive yields higher
Nick recommends a barbell strategy, with longer-dated US Treasurys and triple-A rated sovereign notes from companies like Germany and Sweden on one end, and attractively valued equity holdings on the other. The middle would include investment-grade corporates, high-yield Treasurys, convertible bonds and defensive stocks.
"Equities are going to be tough to pick individually in a declining market...You want to be in our opinion looking at higher-quality fixed-income," says Steve Baffico, senior managing director at Claymore Securities in Chicago. "That brings you to things like corporate bonds, asset-backed securities, even into the high-yield market, where there's a degree of undervaluation and some pretty high-quality product that's mispriced."
As with the question of whether the economy will enter a double-dip, the situation with deflation may be as much perception as reality.
Analysts say the economy may not actually meet the dictionary definition of a double-dip, though it will still feel like one. The same may be true for deflation, defined as a drop in prices often due to a decrease in money supply.
The Consumer Price Index has declined for three straight months but is up 1.1 percent for the 12-month period ended June 2010. And inflation slipped to 1.05 percent in June but trended above 2 percent for the preceding five months, according to the Bureau of Labor Statistics.