Ben Bernanke's Big Bet

This article is part of our Rising Star Portfolios Series.

"Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost ... We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation. Of course, the U.S. government is not going to print money and distribute it willy nilly."
-- Ben Bernanke 2002, Deflation speech

The Federal Open Market Committee met today to unveil its much-anticipated quantitative easing program, better known as QE2. Fed Chairman Ben Bernanke is making a big bet that pumping fresh cash into the financial markets (again) will unleash the almighty wealth effect and kill fears of deflation for good. Picture deflation-induced zombies approaching Bernanke's house as he paces inside, rifle on his shoulder, literally sweating bullets as he ponders how best to use his depleting ammo.

Time for some pump priming
In the second round of QE, the Federal Reserve will print brand-new money, then use it to buy Treasuries from approved banks like Goldman Sachs and Deutsche Bank. The newly printed bills then flow into the markets when the banks themselves or their clients, which include pension, hedge, and sovereign wealth funds, reallocate the capital. Other investors who fear inflation are apt to stop hoarding cash and Treasuries and move on to riskier assets.

I'll save my armchair economist act for another show. Instead, I want to discuss some investments that have become the topic of conversation with friends and family heading into QE2.

Emerging markets for growth?
New capital is likely to flow all over the globe in search for returns. According to Charles Schwab, investors' appetite for growth abroad has grown of late. International mutual funds had a big jump in capital inflows in September, while domestic stock funds gave back capital for the fifth consecutive month. If you can withstand some volatility and are willing to search for good deals, emerging markets make sense.

One bright spot I particularly like is China's love of basketball. Believe it or not, basketball may have surpassed soccer as the world's leading sport thanks to hundreds of millions of NBA fans in China. Nike (NYSE: NKE), Adidas, and China's very own Li Ning have built brands locally and staked a firm claim: It's estimated there are some 300 million casual b-ballers in China. That's ridiculous. Another household name making inroads in China is status symbol Coach (NYSE: COH) with its fancy handbags and impressive management team.

All four of these stocks are fairly high on my watchlist; you can stop by my discussion board to chat about any stock mentioned in this piece. Onto the next asset class ...

Should I be buying commodities?
The whole act of flipping the switch on the "electronic" printing press essentially makes speculation in "limited" resources such as commodities gain fervor. If investors feel that cash is trash and inflation is imminent, a rush to commodities may continue. Since Bernanke alluded to QE2 on Aug. 30, copper and agriculture ETFs have rallied while natural gas remains an outcast -- selling below the average cost of production. The commodities that pique my interest -- oil and agriculture -- are tricky for small investors to truly get at, and ETFs offer a subpar alternative.

Gold and silver are still near all-time highs, and with a bit of "shock and awe" maybe they go even higher. These precious metals typically shine brightest when confidence in the dollar wanes. While I get the argument for precious metals, I pass every time. For investors determined to protect their purchasing power, you may want to check out a closed-end fund like Central Fund of Canada, which actually holds physical gold and silver.

Where's the low-hanging fruit?
If I were the lucky recipient of billions in deployable cash, I'd start with high-quality, cash-rich blue chips, which provide some safety, dividends, and upside over the long haul. I've rounded up several of my favorite blue chips that trade below fair value despite September's market rally. The companies' access to cash to buy back stock on the cheap is attractive in itself.

Source: Capital IQ a division of Standard & Poor's.  *Annualized growth rate over past 3 years.

What if it backfires?
If Bernanke is unable to unleash the wealth effect and the flow of cash in the real economy remains dismal, it's nice to have your friendly dividend stocks willing to pay you 3%-4% on your original investment. A nice healthy mix of share repurchases, dividend per share growth, and price appreciation is what we are looking for. Below are some dividend payers that are high on my watchlist.

Sources: Capital IQ, a division of Standard & Poor's, and Yahoo! Finance.

Come on, just say it
In a conspiracy theory that Jeremy Grantham would surely appreciate, what if QE2 is simply politically motivated? According to Grantham, the Fed has stimulated the economy -- typically via lower interest rates -- heading into virtually every third year of the presidential cycle in an effort to boost the incumbent's chance of reelection. Heading into President Obama's third year, here we are again -- but this time, interest rates can go no lower. Then again, given American voters' historical tendency to decide elections based mostly on the strength of the economy, perhaps we're all to blame.

You can catch my first buy and follow all my buys and sells in my real-money portfolio on my analyst page.

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