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Why U.S. Stocks Are Going to Kill Your Portfolio

Does this year's $1.6 trillion deficit scare you? What about the multitrillion overspending of next year and the year after that? Are you worried that the Federal Reserve's "teaser" rates to banks will come back to bite us?

The U.S. government has attempted drastic fiscal and monetary solutions to generate inflation -- any ol' inflation will do -- to get the economy moving again. For the moment, those efforts have propped up ailing banks such as Capital One Financial (NYSE: COF  ) and Fifth Third Bancorp (Nasdaq: FITB  ) .

But what happens when inflation does come back? The government's printing presses have been working nonstop for months, and when economic growth does return, inflation is going to kill your returns.

If they're too exposed to the dollar
Now, to be sure, many economists, including Nobel laureate Paul Krugman, still believe the more immediate concern is deflation. And it's true that as long as the Fed can't generate inflation with interest rates near 0%, deflation will be a real prospect. But as economic growth picks up, hyperinflation will become an increasing concern.

Why does it matter for your returns? Researchers have found that stock returns are negatively correlated to expected and unexpected inflation. And no less an investing light than Warren Buffett has explained how inflation robs the equity investor.

Sure, Fed Chairman Ben Bernanke is well aware of the dangers of inflation and has promised to drain liquidity from the system quickly once inflationary pressures present themselves. He has even warned Congress about spending too much. But monetary policy is notoriously slow to take effect, and the legislature is about as loath to cut spending as a contestant in an all-expenses-paid spree.

We're already seeing the effects. Oil prices are increasing, swallowing much of the stimulus money that is being doled out weekly in dribs and drabs and threatening the nascent recovery. Interest rates are starting to creep up, an ominous sign for millions of underwater mortgage owners. Until things are definitively clear, the government will be backing easy money, and Wall Street will push both the government and the Fed to continue expansionary policies until the economy clearly emerges from its doldrums.

But with savings rates skyrocketing and Americans reluctant to spend, that definitive recovery could be years off -- and in the meantime, inflation will eat away at your returns.

But all this is happening in dollar-land
If you're as concerned about inflation as I am, it makes sense to invest in something besides dollar-denominated assets. Prudent purchases of high-quality, high-growth foreign companies can be just the thing to diversify against the risk of dollar inflation.

Here are just a few of the compelling investment opportunities around the globe:



P/E Ratio

Sales in North America

Past-Five-Year Compound Earnings Growth

Return on Equity (TTM)

Chemical & Mining Co. of Chile (NYSE: SQM  )






China Mobile












Wipro (NYSE: WIT  )






Telefonica (NYSE: TEF  )












British American Tobacco (NYSE: BTI  )






As of Oct. 7, 2009. Data provided by Capital IQ and Yahoo! Finance. TTM = trailing 12 months.

Notice that these companies operate in a variety of countries. Just as you want to diversify your portfolio away from the dollar, your portfolio should also have exposure to a variety of currencies to hedge against the prospect of unsound fiscal and monetary management in any one of them.

For example, as the Chinese yuan appreciates against the U.S. dollar, owners of China Mobile will capture foreign-exchange gains in addition to the swift growth that the company is realizing. In the case of China Mobile, you'll capture 100% of those currency gains, because the company does no business in the U.S. or elsewhere.

However, if you'd like more balanced exposure to a variety of currencies, then you might select Unilever, which derives about one-third of its revenue from the Americas, one-third in Europe, and the last third in Asia and Africa. This balanced business offers you a natural hedge against major currencies and has some of the most globally recognized consumer brands to boot.

In other words, as dollar inflation heats up, you'll be protected by your foreign-based investments.

Go further west
And this is a perfect time to buy, because global equities have experienced a temporary downturn. At Motley Fool Global Gains, advisors Tim Hanson and Nathan Parmelee have recommended rock-solid companies across the globe that can profit even when inflation hits the U.S. -- and it surely will. You can read all about them by clicking here to join Global Gains free for 30 days.

Already subscribe to Global Gains? Log in here.

Fool contributor Jim Royal does not own shares of any company listed in this article. Unilever is a Global Gains recommendation. Unilever is also an Income Investor pick. The Fool has a disclosure policy.

Read/Post Comments (2) | Recommend This Article (5)

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  • Report this Comment On October 09, 2009, at 6:52 PM, joshbull33 wrote:

    You know, Capital One seems to continuously be beat up in the media because it has a credit card business. However, it shocks me that the media, including the author of this article, continue to call Capital One an "ailing" bank, when it is by far the most sound financial institution in the country. This is supported by every metric used to analyze banks. Perhaps the author should look into that.

    Has the media read the results of the Stress Test? Has the media kept up with what has happened with the repayment of TARP? The answers to both questions is: apparently not.

    Capital One outperformed EVERY other financial institution in the U.S. in the Stress Test, including money center banks and those that don't have large consumer lending businesses. COF has more capital, more equity, more reserves than any other financial company. While charge-offs in every line of business are up at COF due to the economy (just like with every other financial institution in the U.S.), it's losses are well below its reserves. It is not reliant upon the capital markets to fund its business, and it has about $40B in liquidity.

    Capital One did not need to take TARP money, but the Fed forced it to (along with some other banks who didn't need it - an attempt to keep the banks who really did need capital from being labeled). Capital One repaid its TARP preferred shares as soon as it was allowed. It met the government's requirements of issuing additional stock and bonds in the market, even though it did not need to issue additional capital for ANY reason other than to satisfy this government requirement to repay TARP. It has not purchased the TARP warrants back from the government because the government is trying to maximize its profit on those warrants (assets that do not have a way to value them) despite multiple offers from COF to buy them at favorable prices. Perhaps the media should write about the government not wanting to unload its ability to own common stock of U.S. corporations.

    Before the media calls COF an "ailing bank", it should do some serious research because "ailing" is not an accurate description at all.

  • Report this Comment On October 23, 2009, at 11:48 AM, stanton17 wrote:


    A very well stated argument...

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