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Thursday, December 31, 2009

Bonds are risky when inflation is set to explode

In February 2009, Steve Hanke was recommending gold and TIPS (see my previous post). Here are his recommendations at the end of November 2009:
With the Fed intent on keeping interest rates artificially low for an extended period of time, some of my previous recommendations should still work well. In September I recommended tapping into gold and commodities via the SPDR Gold Shares (GLD), iShares S&P GSCI Commodity-Indexed Trust (GSG) and PowerShares DB Commodity Index Tracking Fund (DBC). Since then, these funds have appreciated by 13% to 15%, while the S&P 500 has notched a 9.2% gain. Retain these positions to protect your portfolio from the Fed.

With the inflationary wolf at the door, what's an income investor to do? Go for dividends.

Leggett & Platt ( LEG - news - people ) (LEG, 20), a manufacturer with a product line that started out as bedsprings and veered off into things like parts for farm machinery and retail shelving, generates plenty of cash, even when sales slump. The dividend, which eats up 50% to 60% of earnings, was raised last year and now comes to an annual 5% of the share price. Management has also spent cash on stock buybacks, shrinking the number of shares outstanding by 15% over the past three years.

Philip Morris International (PM, 50) is the second-largest tobacco company in the world. PM claims almost 16% of the non-U.S. cigarette market, a big plus for dollar bears. The market is currently pricing in a revenue growth rate that is lower than what the company has enjoyed over the past five years. The yield is 4.56%.

With its acquisition this year of Alltel ( AT - news - people ), Verizon Communications ( VZ - news - people ) (VZ, 30) has a customer base equal to 30% of the U.S. population. Annual revenue growth over the past ten years has averaged 11.9%. But Verizon is not receiving much credit for its rapidly growing wireless business (it owns 55% of Verizon Wireless). This segment is growing at an annual rate of 17% and is now larger than the wire-line side of the business. The dividend yield is 6.4%.

Kellogg ( K - news - people ) (K, 53) has a yield of only 2.8%, but its dividend is well covered (it uses up only 44% of earnings) and has enjoyed seven increases over the past ten years. The cold cereal company gets 34% of its revenue from outside North America. That portion will go up, so here is another hedge against a weak dollar, as earnings abroad get translated into EPS gains here. Wall Street is expecting mediocre growth--too pessimistic. Take a bite.
--from "Income During Inflation / Bonds are a risky venture when inflation is set to explode at any moment. Play it safe. Go for dividends." by Steve Hanke

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