Assuming the stock market doesn’t move much from here, a typical U.S. company can expect its pension expense – a direct charge against profits – to increase between 20% and 30% in 2009.

With such a hefty burden ahead, it’s not difficult to understand that this pension fund crisis will certainly exert a downward pressure on corporate earnings, and doubtless on stock prices, too.

But there is a silver lining: By choosing your stocks carefully, you can dodge this pension-fund crisis altogether. To make sound choices, it’s first necessary to have some knowledge of pension systems, and the funding crisis that’s brewing up like a summer squall.

Pension-Fund Proliferation Leads to Pension-Fund Crisis

The pension fund problem emanates from the huge expansion of pension funds after World War II, when companies saw additional pension promises as being cheaper than cash wage increases. And they were cheaper: Big industrial companies like General Motors Corp. (GM) were growing rapidly, meaning they had relatively young work forces who could be expected to pay pension contributions for many years before being eligible to receive pensions.

Add a certain amount of old-fashioned sloppiness in the accounting – for instance, the total value of pension liabilities didn’t have to be reported at all until 1985, and have only been brought onto the corporate balance sheets under the recent pension-focused accounting rule, SFAS 158 – and you can see why defined-benefit pension plans, in which workers got a benefit based on a percentage of final salary, were popular with all concerned.

The defined-benefit pension system got into serious trouble in the 1980s – thanks to some developments from the decade before. Under the ERISA Act of 1974, employers were forced to make payments to the Pension Benefit Guaranty Corp., so employees would be paid if the employer went bust. As the 1970s wore on, high inflation (which led to higher wages, and therefore higher pension obligations) and lousy stock markets (which reduced the pension funds’ returns), caused many defined-benefit pension schemes to become seriously under-funded, creating a major risk to employee benefits.

The Generally Lousy Moves of General Motors and General Electric

The aging work force didn’t help: By 1980, GM had stopped expanding and was moving towards its current position, in which retirees outnumber active workers.

The industry’s new solution was the so-called defined-contribution plans, such as today’s ubiquitous 401(K) accounts, in which employers and employees combine to fund employee pensions. These had one modest benefit for the employee: They were much more “portable” than defined-benefit plans.

Under the old pension system, if you had completed 20 years at General Motors, you were basically stuck there until retirement. And employers really liked 401(K) plans, as well, for this new format meant that they were freed from being responsible for employees’ welfare in retirement (a huge cost savings in the retirement area, thanks to the massive escalation in health-care costs, as it turned out). Employers also could generally substantially reduce the percentage of employee wages they devoted to pension contributions.

Defined-benefit plans had something of a comeback in the 1990s, when inflation declined and the stock market rocketed ahead so fast that the under-funded pensions of the 1970s disappeared, and were replaced with over-funded pension plans, so that employers no longer needed to make contributions. The result was that many companies took holidays from making pension contributions, boosting their earnings, their stock prices and the value of their top management’s stock options by doing so.

General Electric Co. (GE) even went further; it figured out a way in which it could make negative pension contributions, essentially withdrawing money from the pension fund, and boosting its earnings still further by doing so. GE Chief Executive Officer John F. “Neutron Jack” Welch (whose tenure at GE was from 1982-2001) never missed a trick – as that company’s unfortunate shareholders, employees, and customers are only now discovering.

Possible Pension Profit Plays

Since 2000, stock market returns have been lousy. What’s more, bond yields have declined. That’s had the effect of raising the nominal value of pension liabilities, which are calculated 30-40 years ahead and then discounted back to the present day by some appropriate bond rate.

When you factor in the recent downturn, it’s easy to see why defined-benefit pension contributions will be zooming up.

So, how do you deal with the pension-fund crisis?

If you were an income investor, to balance those high yields, you also had to have capital appreciation, so about half your portfolio would be invested in U.S. common stocks – which, thanks to their dividend payouts, yielded a good 3%-4% themselves. Even after you paid Uncle Sam, a portfolio such as this one would have easily thrown off 5% of its value in income, and allowed you to keep up with inflation as stock prices generally rose.

Clearly, those were the halcyon days for income investing.

More than two decades later, income investors face a much bigger challenge. U.S. stocks have posted mediocre results since 2000, while bonds and cash have provided truly lousy returns after inflation and taxes are taken into account. Stocks pay lower dividends than they used to, especially since top corporate executives now are loaded up with stock options, and those decline in value every time a dividend payout extracts a big slug of cash from the corporate coffers.

The bottom line: While stock prices, interest rates, and inflation are at current levels, and U.S. economic growth remains sluggish, income investors who focus only on domestic income investments will be lucky to break even in cash terms after they have attempted to live on 5% of their capital.

There is a solution, however. In fact, this particular income strategy can offer much better returns than anything a domestic income investor can ever hope to find. We’re talking, of course, about investing internationally. Most investors think of the international markets only as another place to seek out stocks. But overseas financial markets are a great option for income investing, as well. And here’s why.

The Overseas Option for Income Investors

• The United States continues to run an annual balance-of-payments deficit of $700 billion. As long as that persists, the dollar will tend to be weak against other currencies. Sometimes, even low-risk investments in the right foreign currency can provide substantial capital gains – and it’s not always the obvious currencies. Did you know you could have made more than 30% in dollar terms during the past year from a bank deposit in Czech crowns? And that wasn’t some wild investing gambit: These days, the Czech Republic is a perfectly solid middle-income democratic European Union member with an admirable free-market president, Vaclav Klaus.

• Because U.S. interest rates are so low, many countries have higher interest rates – with lower rates of inflation. Australian, Brazilian, and New Zealand bank deposits all pay more than 5%. All three currencies have recently been strong against the dollar and will likely continue to perform so. And all three of those economies have inflation rates that are comparable to, or lower than, the United States’ rate of inflation (South Africa also has 8% deposit rates, but there inflation is too high for safety).

• While the U.S. economy scuffles along at a 1% pace – and even if it were to recover to 3% – there are a number of countries with growth rates of 5% or greater, not all of which have overvalued stock markets. China and India famously have growth rates of 9%-10%, but what about South Korea and Taiwan? Both are richer countries with growth rates consistently in the 5%-6% range. By definition, if stocks in those countries are no more expensive than in the United States, they are likely to offer better value.

• Many stocks outside the United States pay generous dividends, often because they are still controlled by the original founding families who want the income, or because these firms are based in companies with are located in countries with good-value stock markets.

International Income Investing: The Secrets of Success

For income investors seeking dividends from international investments, the secret is to find companies with high dividend yields, but which aren’t operating in the kind of risky or highly cyclical business sectors that will make those dividends vulnerable.

In other words, what you don’t want to see is a situation where you buy into a stock for its hefty dividend yield – only to have the board of directors of that company suddenly decide that it needs to conserve cash. For instance, Telecomunicacoes de Sao Paulo SA (ADR: TSP), the fixed-line telephone system in Sao Paulo, Brazil, has a dividend yield of no less than 14%. However the company’s profit margins are under attack by the aggressive cellphone operators in the country and its earnings seem likely to decline. Indeed, the consensus forecast for TSP’s 2008 earnings is about 30% less than the dividend payout, suggesting that dividends will be forced downward – unless the company starts liquidating itself.

Some current recommendations that have good dividend payouts that are also securely covered by earnings:

• Kookmin Bank (ADR: KB): The largest bank in South Korea, Kookmin has a dividend yield of 4.6% and a Price/Earnings (P/E) ratio of less than 8.0. Kookmin has avoided an entanglement in the U.S. subprime-mortgage mess, but has nevertheless been dragged down by investor disillusionment with the financial services sector.
• Acer Inc.: Based in Taiwan, Acer is now the world’s third-largest manufacturer of PCs, with a global market share that reached 10% since its 2007 purchase of Gateway. Although there are several ways to invest in this company, this is best bought through its Global Depositary Receipts, which are listed on the London stock exchange (ACID). Acer has a dividend yield of 6.4% and a P/E ratio of only 11.0 – pretty alluring numbers for a leader in a major growth sector.
• Tele Norte Leste Participacoes SA (ADR: TNE): Also known as TNE, Brazil’s cellphone compay has a yield of 4.8% and is trading at about seven times earnings.

One final note: Income investing is all too often viewed as a stodgy, no-growth strategy for the total risk-averse. But as Acer and TNE demonstrate, you don’t need to confine yourself to stodgy, low-growth sectors to get a juicy dividend yield with good security. You just have to look globally.

[Editor’s Note: When it comes to global income issues, Money Morning Contributing Editor Martin Hutchinson knows his stuff. An investment banker with more than 25 years’ experience, Hutchinson has worked on both Wall Street and Fleet Street and is a leading expert on the international financial markets. In February 2000, as an advisor to the Republic of Macedonia, Hutchinson figured out how to restore the life savings of 800,000 Macedonians, who had been stripped of nearly $1 billion by the breakup of Yugoslavia - and then the Kosovo War. Hutchinson’s "Insights on Income" column will now be a regular feature in Money Morning].

Source: Insights on Income: Foreign Markets are a Necessary Profit Play for Today’s Income Investor

You may reasonably ask why you should care. There are, after all, about 183 countries in the world, perhaps 100 of which are more or less democratic in nature, which gives you roughly 30 elections a year to worry about. Figuring out who are the “good guys” in that number of races is absolutely impossible – even in Korea, which is one of our more-important trading partners.

Every now and then, however, an election brings a change that is truly significant, either politically or economically. In Korea, this election has brought significant positive economic change.

Since the Asian crisis of 1997, Korea has been run by the center-left. That group didn’t do too bad a job: Economic growth ticked along at an average annual rate of between 4% and 5%. The per-capita growth rate is about the same, given that Korea has only 0.4% per annum population growth. There’s a budget surplus, and the country also boasts a balance of payments surplus. Overall inflation is only 2.5%. The stock market is around double its 2003 level, which is when the previous [and now-outgoing] government came into power.

As nice a job as the outgoing government managed to do, its policies also included a few that held back growth. For instance, government spending rose from 21% of Gross Domestic Product (GDP) to 28% over the decade the left was in power. That increase in government outlays saps resources from the private sector by diverting the resources into less-productive public sector uses – reducing the economy’s overall productivity growth.

The outgoing government also imprisoned the chairmen of three of Korea’s top six chaebol conglomerates, and placed severe restrictions on their expansion. SK Telecom Co. Ltd. (SKM), for example, part of the Sunkyong Group, was not permitted to increase its cell-phone market share significantly above 50%. Only after Lee’s presidential election victory in December did restrictions start to relax. In February, SK Telecom was permitted to acquire 44% of its competitor, Hanarotelecom.Inc. (OTC: HANAY).

However, President Lee’s more free-market approach seems likely to ratchet Korean growth up a notch. He ran for election on the platform that Korea should expect a growth rate of 7% – not 5% – and with a budget surplus and low inflation rate he is well positioned to deliver his goal. Lee has promised both corporate and individual tax cuts, and a major program of privatization, starting with three state-owned banks – including the Korea Development Bank.

He is also likely to take a tougher stance toward the potentially volatile leadership in North Korea, cutting back on handouts and adopting a harder line against its northern neighbor’s alleged nuclear-weapons programs. This newfound aggressiveness by the South Korean leadership will save money both for the government and for the big conglomerates, since they had been expected to undertake unprofitable prestige projects in the North.

There are five Korean stocks that have American Depository Receipts (ADRs) that are fully listed on the New York Stock Exchange and that trade in reasonable volume. Some of these are more attractive than others-Kookmin Bank and SK Telecom in particular seem especially good bargains. Let’s take a look at each of the five, starting with an overview and including an investment rating on the shares:

• Kookmin Bank: (KB): The largest bank in Korea, KB has been hit by investor disillusionment with the financial services sector; at one point it was down 50% from its 2007 high. However, the stock has rallied recently. The bank’s earnings have continued to make steady progress and it has no exposure to the U.S. subprime mortgage market. Kookmin’s shares are trading at a Price/Earnings ratio of only 7.5 on trailing 12 months’ earnings, and its P/E on projected earnings for the next 12 months is a staggeringly low 6.6. Those earnings are expected to increase in a big way. One last benefit: Kookmin’s shares feature a dividend yield of 4%, which is more than you’ll get out of Treasuries these days. Rating: “Strong Buy.”

• Korea Electric Power Corp.: (KEP): Shares of the Korea’s electric power company are up slightly from where we recommended them back in December. The shares feature a P/E of 11 on projected earnings, and a dividend yield of 2.4%. KEP’s steady growth should benefit from any acceleration in Korea’s economic growth rate, but it is forced to buy coal from overseas, which has doubled in price in the past year. With an election in the offing, it suffered from price controls in the latter part of 2007, but should presumably have more freedom to raise its tariffs going forward. Rating: “Hold.”

• KT Corp.: (KTC): Formerly Korea Telecom, KT is now Korea’s leading “fixed-line” telecommunications provider, which was privatized in 2002. While the P/E ratio on trailing earnings is less than 9, its forward P/E is 11.5 as its margins are under assault from the hyper-competitive Korean telecom market. It has a dividend yield of 4%. Rating: “Hold.”

• Posco: (PKX): Korea’s largest steel company, and the world’s most-efficient steelmaker, Posco’s shares sport a Price/Earnings ratio of about 11, and a dividend yield of 2%. The company is a major exporter into China, making it a key participant in that country’s explosive growth. The company does buy its iron ore from Brazil’s Vale (RIO), and was socked with a 65% price increase in this crucial raw material. But don’t forget that investment guru Warren Buffett made Posco one of the 20 Korean companies he invested in last year. If nothing else, that’s a reminder that Posco will become very attractive when the commodities bubble deflates, even though it may be a tad early to make your move right now. Rating: “Buy/Hold.”

• SK Telecom: (SKM): It’s Korea’s largest mobile phone company, with operations in China and Vietnam. The stock is now trading at only 8.7 times estimated 2008 earnings, and has a hefty 4.9% dividend yield – so income investors do well from it, also. For many years, its market share in Korea was capped at 50%. But now the shackles are coming off; in fact, SKM recently got the green light to buy 44% of Hanarotelecom, Korea’s second-largest cell phone company. In 2006, SKM invested in a $1 billion convertible offering for China Unicom, Mainland China’s No. 2 mobile-phone company; in August 2007, the bonds were converted into a 6.6% in China Unicom with a current value of almost $2 billion. In Vietnam, SKM’s 73% owned Vietnamese subsidiary had 3.5 million subscribers in 2007, and it’s now aiming for 5 million in 2008. Only its U.S. operations are showing losses, but even those could turn around. Rating: “Buy.”