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

In fact, a big reason why Brazilian stocks have dropped is because the country’s central bank has been forced to raise rates to curb inflation. Policymakers have raised the benchmark rate twice since April, to 12.25%. Of course, inflation isn’t a problem unique to Brazil.

Inflation in India has been at alarmingly high levels since the first week of June, when it jumped from 8.75% to 11%. And many analysts expect government data released today (Friday) will show wholesale prices soared to a 13-year high of 11.75% in the week ended June 28.

China’s consumer price index (CPI), the nation’s primary gauge of inflation, increased 7.7% in May, after hitting a near 12-year high of 8.7% in February, and is expected to rise 7.2% year-over-year in 2008.

The European Central Bank raised its key interest rate a quarter point last week, after inflation hit a 16-year high of 4% last month, and U.S. Federal Reserve Chairman Ben S. Bernanke has also struck a more hawkish tone with regards to tightening monetary policy.

Brazil, said yesterday that its benchmark IPCA inflation rate rose 6.06% in the past 12 months, higher than the central bank’s 4.5% target, but still below the spiraling rates of China and India, and only marginally higher than inflation in the European Union. Today’s inflation rate is also a marked improvement over the 12% Brazil clocked in 2002.

Also, unlike the United States and Europe, which are both grappling with sluggish growth as well as soaring inflation, the Brazilian economy is expected to expand by a bullish 4.8% this year. And there are two big reasons why.

Brazil’s Booming Consumer Class

By 2030 an additional 2 billion people will have joined the global middle class, according to research by Goldman Sachs Group Inc. (GS). That’s a third of the world’s population and enough to cause a “shift in spending power towards middle-income economies.” With its rapid growth and abundance of resources, Brazil figures to be a major focal point of that shift.

In the past two years, more than 23 million people have leapt from Brazil’s lower income classes into “Class C,” which is defined by households with incomes between $450 and $745 a month. Class C, Brazil’s middle class, now makes up about 46% of the country’s population, according to Reuters.

The percentage of the population that makes up the lowest two classes, “Class D” and “Class E,” dropped from 51% to 39% from 2005 to 2007.

This shift has caused a boom in consumerism throughout the region. Household consumption rose 6.6% in the first quarter of this year, according to the nation’s statistics agency.

While the majority of incomes have traditionally been spent on staples such as food, an increase in household wealth has resulted in a surge in spending on luxury goods. Sales of big-ticket items, like cars, homes appliances and electronics, have jumped 80% since 2005, according to Forbes. Brazil has also become the fifth largest cosmetics consumer in the world.

Domestic demand has also been fueled by an increase in credit. The number of credit cards in Brazil rose 91% between 2002 and 2006, to 79 million, or one for every 2.3 people. And consumer loans, excluding credit cards, are expected to grow by 25% this year after soaring 40% in the first quarter, Erico Ferreira, president of the National Association of Credit, Financing, and Investment Institutions told Bloomberg News.

The surge in spending helped Brazil’s services industry, which accounts for about 60% of the economy, to grow 5% in the first quarter. Increased demand also boosted manufacturing by 6.9%, and agriculture, which now accounts for less than 10% of gross domestic product (GDP), grew 2.4%.

“Brazilians don’t get scared by 6% inflation,” Ferreira told Bloomberg. “Companies want to profit from the growing economy and they know that to do so they need to offer longer maturities at lower rates.”

Brazil Makes Some New Friends

Another big reason investors should keep believing in Brazil is that it has made some powerful new friends abroad.

Brazil’s resources are highly coveted by other emerging markets, particularly fellow BRIC country China, who is desperately seeking fuel for its own economic expansion. Brazil sent 6.7% of its goods to China last year, double the level of 2001.

Trade volume between China and Brazil totaled $29.7 billion in 2007, jumping 46.4% year-over-year, according to the latest statistics of China’s Ministry of Commerce.

Perhaps that’s why the Brazilian government has launched its “China Agenda” program, which involves a series of coordinated measures by the government and private sectors to triple Brazil’s exports to China and encourage more Chinese investment in Brazil.

According to Xinhua, Brazil wants to triple its exports to China from $10.75 billion in 2007 to $30 billion by 2010.

The Brazilian government has identified 619 products that are in high demand in China as priority export items to the country. Meanwhile, the government has also proposed to include more manufactured products in its exports to China, 74% of which now are low-value commodities such as soybeans and pig iron.

Brazil has also sought out stronger ties with Middle Eastern powers. Most recently, plans were made to establish a permanent commercial center in the United Arab Emirates to promote investment between the regions. The U.A.E. is home to the Abu Dhabi

Investment Authority, or ADIA, a sovereign wealth fund with an estimated $875 billion in assets. Brazil is the world’s sixth-largest economy and home to an internal market of approximately 190 million consumers.

In pretty short order, all the charge-card companies boost his credit limits, cut the interest rates he’s paying on his outstanding balances, offer him new credit lines – and even make him eligible for various “rewards” programs that give him all sorts of freebies for spending money.

Brazil finds itself in that situation because uber-debt-rater Standard & Poor’s just boosted the country’s credit rating to “investment grade” in recent weeks, moving its rating from BB+ to BBB-. Why should we care? After all, isn’t Brazilian debt bought mostly by institutional investors? That’s true. But with the increased debt rating, Brazilian shares also should benefit – provided the government doesn’t embark on a big spending binge.

Brazil was included in the “BRIC” (Brazil, Russia, India, China) group of rapidly growing emerging economies that was created by Goldman Sachs Group Inc. (GS) back in 2003. At that time, it really didn’t deserve the distinction. Long-term growth since the 1970s had averaged less than 2% per capita, and the country had narrowly avoided bankruptcy only the year before. Long-term interest rates were above 20% (around 15% in real terms), which hardly encouraged companies to make capital-spending commitments that might grow the economy. Most alarming, a left wing socialist named Luis Inacio Lula da Silva had just been elected president.

Brazil got lucky. First, Lula proved to be surprisingly moderate, not much to the left economically of previous Brazilian governments, perfectly willing to welcome foreign investment, generally friendly to the United States and not at all like his socialist neighbor, Venezuelan President Hugo Chavez. Second – and probably even more importantly – 2003 was the year in which energy and commodity prices began the long climb that has brought them to their current (astronomical) record levels. Third, since Brazil was not an oil exporter, there was no single source of new wealth that the government could just seize. Instead, revenue flowed to mining companies, the oil company Petroleo Brasileiro SA (usually referred to as just Petrobras) (ADR: PBR), and numerous agri-business operations that benefited from the rise in agricultural prices.

Most startlingly, Brazil’s ethanol program, which had been a hopeless boondoggle for a generation since it started during the oil crisis of 1979-82, suddenly became the envy of the world. Rising oil prices made Brazilian sugarcane the world’s cheapest and most economically and ecologically efficient source of newly fashionable ethanol. At a $20 per barrel oil price, the ethanol-from-sugar program was a typical example of misguided Third World government planning; at $120, it is a bonanza.

Brazil’s debt position has improved in three ways:

• The amount of outstanding debt has been reduced through modest repayments.
• Its ratio of debt to gross domestic product (GDP) has dropped sharply, as GDP in dollar terms has shot up with the revaluation of the Brazilian real against the dollar.
• And Brazil’s interest costs have dropped along with the country’s improving creditworthiness and with the generally low level of global interest rates.

With more income, a stronger currency and lower debt, it’s not surprising that Brazil’s credit rating has improved. As with an individual consumer on whom the credit card gods suddenly smile, what happens next depends on what use is made of the improved position. If a person reverts to their earlier spendthrift ways, they will quickly max out the new credit limits, actually making their position even worse than before.

Fortunately, the Brazilian government appears to have learned the difficult lessons of the last 25 years, and is remaining both careful in its spending and welcoming to foreign investment. That will bring down Brazil’s debt costs further, as will recent favorable developments like the discovery by Petrobras of about 36 billion barrels of oil in an offshore Brazilian oilfield.

Now, don’t get carried away. This isn’t China – with its 10% annual growth rate, apparently repeatable ad infinitum. Brazil had such growth rates for a brief period in the 1970s, but they disappeared around 1980 in a blizzard of unpaid debt. Brazil’s growth rate is currently around 5% – but it looks far more balanced and stable than it did in the 1970s. Brazil’s improving credit position is likely to make growth persist, and future political risk appears minimal. When Lula goes, a politician of the center-right could well replace him.

Another good sign for Brazil – there are more than 30 Brazilian companies with full American Depository Receipt (ADR) listings on the New York Stock Exchange, plus 40-50 more that are traded in the over-the-counter market. Here are a few attractive examples to consider:

Banco Itau Holding Financeira SA, referred to usually as Banco Itau (ADR: ITU), has a Price/Earnings ratio of 14 and dividend yield of 2.4%.  Brazilian banks earn very high returns, primarily from domestic market lending in reals. Including Banco Itau, there are three large ones listed on the Big Board in New York; the other two are Banco Bradesco SA (ADR: BBD) and Uniao Bancos Brasile SA (Unibanco) (ADR: UBB). However, Itau is the cheapest of the three, though only slightly.

Companhia Vale do Rio Doce, now referred to only as Vale (ADR: RIO), is one of the true global blue chips, with a market capitalization of almost $200 billion. An iron-ore company with ancillary operations in gold, nickel, copper and other metals, its shares trade at a reasonably valued 13 times earnings, though its dividend yield is only 1.2%.

Petrobras (ADR: PBR) is one of the few emerging market oil companies with access to modern technology – and the willingness to work with the oil majors. Its shares are up 168% in the past year, but the stock’s P/E still is only 16. It has a 1.3% yield. The possible upside: It finds another gigantic offshore oilfield. The possible downside: Oil drops back to $50 a barrel. If the world’s monetary authorities get serious about imposing higher interest rates to fight inflation, PBR and RIO would probably suffer as commodities prices fall back to earth.

Companhia de Saneamento Basico (Sabesp) (ADR: SBS) is the water and sewage system provider for Sao Paulo. Now that’s a growth business, and not dependent on commodity prices. With a P/E of only 9.2 and a yield of 2.7%, this is one stock I have to say I love.

TNE (ADR: TNE) There are a bunch of Brazilian cell phone companies, but TNE appears to be the cheapest. It’s concentrated in the populous southeast and northeast regions of Brazil, with a P/E ratio of only 7 and yield of 4.25%.

Telecomunicacoes de Sao Paulo SA, or Telesp (ADR: TSP) provides the fixed line telephone system for Sao Paulo. Before you sneer, consider this: the company has a dividend yield of 9.8% and a P/E ratio of 10 (which means the dividend is only just covered). And it’s majority owned by Spain’s Telefonica.

Voturantim Cellulose (ADR: VCP) is a pulp and paper company, with a P/E ratio of 14 and a dividend yield of 2.8%. Trees grow fast in the tropics and VCP definitely benefits from that!

Source: Is Brazil ‘Investment Grade’ for Investor’s Money, Too?

After months of negotiations, Brazilian telecommunication titan Oi Participacoes TNE has reached an agreement to acquire rival Brasil Telecom BRP, two newspapers reported Friday.

The reported $4.6 billion deal would consolidate a rapidly growing industry in the emerging South American economy, giving Oi – also called Tele Norte Leste Participacoes SA and already Brazil’s biggest phone carrier – a 70% share of Brazil’s fixed-line market.

The newspapers reporting the deal – Folha de S. Paulo and Valor Economico – said the companies will announce more details next week.

The companies have been in talks since early this year. Brasil Telecom top shareholders, including Previ, Citigroup Inc. C and local pension funds, have said they are willing to sell.

Until the deal is official, investors can’t be too certain, as Brazilian law forbids one group from holding two separate telecommunications concessions. Although, the government is seeking ways around the law to permit the takeover, Reuters reports.

The World’s Biggest Emerging Market

Last year, Brazil’s main stock market index, Bovespa Holding SA, rose 71% – even faster than India’s.

And on Feb. 20, Brazil displaced China to become the world’s biggest emerging market, according to a key index – Morgan Stanley Capital International Global Emerging Markets (MSCI GEM).

That shift will likely attract billions in new money to Brazilian stocks, especially from money managers who benchmark their portfolios against the MSCI GEM index.

The bottom line: Expect money to flood Brazilian shares, says Keith Fitz-Gerald, Investment Director for Money Morning.

“Anytime a country moves to the top of that index there’s a strong re-indexing effect,” Fitz-Gerald said. “And that will lead to billions of dollars of institutional money being shifted as those professional investors rebalance their portfolios. They’re going to move substantial amounts of money into Brazilian stocks.”