China’s Inflation Is Coming Our way – The AIA Advocate Newsletter

In This Issue:

If The Economy Falters, Expect A QE3 Rescue

Most Blue Chip Stock Values Remain Attractive

China’s Inflation Is Coming Our way

TIPS Are Becoming Popular Again

Another Effective Inflation Hedge

The Bottom Line This Month

The stock market correction that investors had been expecting for several months finally started in late April. So far, it’s been mild. For the month, the Dow and the Nasdaq declined just 2.9% and 3.9% respectively. Of course, there is a chance that the bear is just getting warmed up.

If The Economy Falters, Expect A QE3 Rescue

The issue that concerns investors the most is what the economy is likely to do after the Fed’s second quantitative easing program (QE2) ends on Friday. Few analysts expect anything will happen right away because stimulus programs have a lot of momentum. By July, however, we should begin to see whether or not growth will continue on its own without federal support.

Predicting what will happen to the economy is difficult because growth is not evenly distributed. Manufacturing is very strong. So are agriculture and many export sectors. However, housing and commercial real estate markets are still sinking. Most other industries are doing okay but not great.

In our opinion, the end of QE2 is of less importance than it may appear. That’s because if growth starts to weaken the Fed will almost certainly step in with another round of easing. Although there would be a delay before a new injection of money could take effect, it seems unlikely that investors would sell stocks off during that period.

Most Blue Chip Stock Values Remain Attractive

Another reason we think the stock market is unlikely to take a severe plunge anytime soon is most blue chip stock valuations are still attractive. Multiples for most leading agriculture stocks, for example, are still in the 10 – 13 range. Archer Daniel Midland (ADM), that rightly calls itself “Supermarket to the World”, has a P/E under 10, http://finance.yahoo.com/q/bc?s=ADM&t=1y. “High-flying” Coca-Cola (KO) is only 13, http://finance.yahoo.com/q/bc?s=KO&t=1y. By contrast, the forward P/E for the Dow is about 14.7.

Valuations are even more attractive in America's successful technology industry. The P/E for Intel (INTC), a company that powers the majority of the world’s computers, is just 11, http://finance.yahoo.com/q/bc?s=INTC&t=1y. Microsoft (MSFT) is selling for less than 10 times earnings, http://finance.yahoo.com/q/bc?s=MSFT&t=1y.

With the price of oil still hovering around $110 a barrel, we would expect the leading energy stocks to be near the top of their historic valuations. Not so. The P/E for ExxonMobil (XOM) is 11.5, http://finance.yahoo.com/q/bc?s=XOM&t=1y. ConocoPhillips (COP) is an even lower 8.5, http://finance.yahoo.com/q/bc?s=COP&t=1y.

Even cheaper valuations are to be found among America’s largest financial service firms. Bank of America (BAC) is selling for only 7.7 times earnings, http://finance.yahoo.com/q/bc?s=BAC&t=1y. Wells Fargo (WFC) barely tips the scales at 8.2, http://finance.yahoo.com/q/bc?s=WFC&t=1y.

We are just amazed at the low blue chip valuations that are common. In many cases, we have not seen their like in over 20 years. It might be another 20 years before we see them again.

Of course, anything can happen on Wall Street. When investors are frightened they don’t look at numbers before they hit the “sell” button. Nevertheless, we think the risk/reward balance for many of America's finest companies is very much in the investor’s favor. The eight blue chip stocks we just mentioned should be top performers for long-term investors.

China’s Inflation Is Coming Our way

Inflation has not been a problem in the U.S. for several years. One of the reasons is China has been flooding our country with low-priced consumer products. More recently, China’s inexpensive exports have blunted the impact of the recession for countless U.S. families that are struggling to cope with reduced incomes.

However, China’s long economic expansion is leading to higher inflation, and it will soon spread to the U.S. China’s official CPI is only 5.3% but that is almost certainly lower than the actual rate. Gasoline prices in the country are up 11.2%. Food increases are harder to determine but they appear to be in the 8.3% range.

Adding to China’s inflation problem are rising commodity prices. They are taking a toll since China must import most of the raw materials it needs for its vast manufacturing industry. To cap it off, China’s workers are demanding, and getting, higher wages. In some sectors, paychecks have gone up 20%.

Until recently, China absorbed rising production costs and kept its prices steady in order to retain market share. That’s no longer possible and Chinese exports to America are starting to go up in price. The result will be higher inflation for our consumers than the Fed has been predicting. Economist John Williams of Shadowstats www.shadowstats.com believes the true rate of inflation in the U.S. is now close to 10%.

TIPS Are Becoming Popular Again

With inflation on the rise, we are again recommending Treasury Inflation Protected Securities (TIPS). These special government bonds have their principal adjusted twice a year to compensate for the rate of inflation.

With TIPS, if you purchase a $1,000 bond and the inflation rate turns out to be 5.0% for the year, its value will be adjusted to $1,050. Consequently, the purchasing power of your money will remain the same as it was when you bought the bond. You are also protected in the unlikely event we have another period of deflation because your final payment cannot be less than the original par value of the bond.

If inflation rises, not only will your principal be adjusted upwards, your twice-yearly interest payments will also go up. So, if inflation occurs throughout the life of your bond, every interest payment will be higher than the previous payment. If deflation occurs, your interest payments will decline.

Investors can buy TIPS directly from the U.S. Treasury Department's Bureau of the Public Debt. The bonds may be purchased in increments of $100. The minimum purchase is $100. The bonds are available in 5-year, 10-year, and 30-year maturities.

Uncle Sam will hold your TIPS in a Treasury Direct Account set up in your name. You can get the necessary information and forms using the link: http://www.treasurydirect.gov/indiv/products/prod_tips_glance.htm

If you don't wish to lock up your money for a fixed period of time, you should consider a TIPS fund. We continue to like the Vanguard Inflation-Protected Securities Fund Investor Shares (VIPSX). http://finance.yahoo.com/q/bc?s=VIPSX&t=2y As with most Vanguard products, the TIPS fund carries no load and has a very low 0.22% expense ratio, vs .85% average for its competitors.

Another Effective Inflation Hedge

Another way to help protect your assets from going through the inflation wringer, is to put some of your money in foreign currencies. For most investors, the object of diversification isn’t to profit from currency swings. That’s a game for experts, and a risky one at that.

Instead, the goal should simply be to preserve the purchasing power of your savings. That’s easy to do with diversified currencies since they are valued in relation to each other. When one goes down others go up, and vice versa.

We continue to think the best and easiest place for investors to set up foreign currency accounts is with EverBank World Markets, or 888-882-3837. You can open deposit accounts in any one of 20 individual currencies or put your assets in one of the bank’s diversified currency CDs. One of the most popular CDs is the Investor’s Opportunity Basket that contains the Australian dollar, euro, Mexican peso, and the New Zealand dollar.

The Bottom Line This Month

The stock market correction that has been expected for several months appears to be underway. So far, the decline has been mild but that is likely to change if the economy stumbles this summer.

Market conditions aside, many high quality blue chip stocks appear to be very attractive. The list includes Archer Daniels Midland, Coca-Cola, Intel, Microsoft, ExxonMobil, ConocoPhillips, Bank of America, and Wells Fargo.

With inflation starting to pick up, we think investors should also consider putting some money in TIPS and foreign currencies.

Until Next Month

The AIA "Advocate For Absolute Returns", a publication of The Association for Investor Awareness, Inc., tracks market trends, industry news, the SEC, global trade and finance and Washington developments for you because they affect your investments. But who doesn't? Many sources report these issues as abstract facts. We feel that's not enough. The AIA Advocate's job is to warn you of what's important and how these developments translate to ground-level forces and threats that directly affect your wealth as well as your current investment opportunities. Not just information, but information you can use. Until next time ...


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Posted 05-26-2011 12:27 PM by Research & Editorial Staff