Money Matters - Simplified

Protect Your Assets From This Looming Risk

The U.S. Treasury is ramping up its issuance of inflation-protected
securities (TIPS) this year, in order to address foreign investors'
concerns about soaring fiscal deficits
and the inflation risk they create. TIPS issuance for 2010 is expected
to increase by approximately 40% over the amount sold in 2009. Should
you be following China's and Japan's impetus and raising your exposure
to TIPS?

How do TIPS work?

TIPS are government
bonds with semi-annual coupon payments and principal that are indexed
against inflation, using the Consumer Price Index (CPI). Individuals
can purchase TIPS directly from the Treasury, but the iShares Barclays TIPS Bond Fund ETF (NYSE: TIP)
is a more convenient option. The trouble is, while TIPS guarantee a
positive after-inflation return, at 1.28% for the 10-year TIPS, the
current "real yield" will only inch your purchasing power forward.

Traditionally, investors have sought protection against inflation in
gold and other commodities, but there may be a more straightforward
option.

A tip from Bill Miller

Last Tuesday, Bill Miller, the manager of Legg Mason's (NYSE: LM) flagship Value Trust fund remarked on CNBC that "the top 10 names in the S&P 500 today trade at around 12 times earning ... they should trade somewhere between 14 and 18 times earnings."

By my calculations, the market-value weighted price-to-earnings
ratio for the basket of these 10 stocks is actually 16.3 (see table
below), but half of them do trade below 15 times earnings: ExxonMobil (NYSE: XOM), Wal-Mart Stores (NYSE: WMT), Johnson & Johnson (NYSE: JNJ), IBM (NYSE: IBM), and Procter & Gamble (NYSE: PG).

Category

Dividend Yield

Price / Earnings Multiple

Long-Term Estimated EPS Growth

Top 10 S&P 500 stocks -- market-cap weighted average

1.7%

16.3

11.2%

Source: Capital IQ, a division of Standard & Poor's.

Lower initial yield ... with upside

Although
the average dividend yield (which is a pre-inflation figure) for this
basket of 10 stocks is lower than the real yield on TIPS, I'll take the
former -- along with the 11% expected annual growth in earnings per
share. My guess is that this basket will outperform TIPS on an
inflation-adjusted basis over the next 10 years. More broadly, asset
manager GMO has "high-quality" U.S. stocks (our basket certainly
qualifies) earning an average real return of 6.8% over the next seven
years, a full 6 percentage points ahead of its projection for
inflation-indexed bonds.

© 2009 UCLICK L.L.C.