In This Issue:

Inflation Spike Seems Unlikely To Last
The Dollar Rally Gathers Strength
Russians In Georgia Have Investors Spooked
The Outlook Is Good For U.S. Defense Companies
In A Low Yield World, Dividends Shine
The Bottom Line This Week

The stock rally lost some ground last week which made many investors worry that the run may be coming to an end. That fear was justified since the main engine behind the rally -falling oil prices- continued to play their part. Even with oil moving down to the $112 range, the Dow fell 0.6% for the week.

Small stocks moved in the opposite direction to their larger cousins as the Nasdaq posted a 1.6% advance. In its own way, the small stock upturn also made investors nervous. The bounce was another in a long list of confusing situations that are at work in the market today.

Some of the fog lifted this week when the Nasdaq got back in step with the Dow. Unfortunately, new concerns about the financial sector pushed the direction down for both of them, which wasn't what investors had hoped to see. By Wednesday afternoon the two indices were off 242.4 points and 63.4 points respectively.

Inflation Spike Seems Unlikely To Last

One reason the summer rally appears to be stumbling is inflation numbers for July were disturbing. The Labor Department said its Producer Price Index rose by 1.2%, more than double the expected rate. It was also the fastest pace we've seen in 27 years.

A second look, however, makes the inflation spike seem less threatening. July was the third month in a row when oil prices made record highs. Under the circumstances, inflation was bound to shoot up. Because energy costs take two or three months to fully impact the economy, we can expect the August inflation rate will also be high.

The good news, of course, is the recent plunge in oil prices should bring inflation back down later this year. We just need to be patient until the lower costs start to give the economy a much-needed boost.

The Dollar Rally Gathers Strength

Another reason the outlook for inflation probably isn't as bad as it appeared to be last month is the U.S. dollar is continuing to rebound. As measured against the euro, the greenback is up 8% since its April 22 low. If the dollar gains additional ground, it will take fewer of them to buy the products we need, and inflation will drop proportionately.

As we said in several recent issues, we think deep-seated problems with U.S. debts, the balance of payments deficit, the housing market, and the economy will start to push the dollar back down a few months from now. Shorter term, however, the greenback should deliver additional profits to aggressive currency investors.

If the dollar rally continues as expected, the PowerShares Dollar Bull (UUP) will reflect the gains. http://finance.yahoo.com/q/pr?s=UUP The ETF mirrors the movements of our currency against the euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and the Swiss franc. Taking a broad measure of the dollar's value is a good way to even out the price swings that often occur in the foreign exchange market.

One of the biggest advantages of the dollar ETF is it is easy to buy and to sell. Just as importantly, you can place a stop loss order on the ETF to protect your position. Using a stop will allow you to participate in the dollar rally for as long as it lasts, and be out automatically once it comes to an end.

Russians In Georgia Have Investors Spooked

In addition to the new worries about inflation, investors are also concerned about Russia's decision to leave many soldiers in Georgia. Although it appears the shooting has stopped, the war could start up again overnight.

Strategically, Georgia is of little importance by itself. However, analysts believe that Russia is using the country to send a message to the Ukraine, Poland, and Central Asia to stay in line, or else. Russia wants them to be free of U.S. missiles and to reject making any new military alliances with the West.

Some political analysts believe that Russia's aggressive action in Georgia indicates that a new cold war may be starting. If so, it won't be good for the stock market. However, many defense issues should prosper.

The Outlook Is Good For U.S. Defense Companies

As it turns out, many leading defense companies are attractive whether or not relations with Russia deteriorate. Many billions of dollars worth in military equipment has been trashed by five years in the harsh environments of Iraq and Afghanistan. Replacing it all should keep the defense industry in clover for several years.

Investors who may be interested in taking a diversified position in the defense industry, should consider the Fidelity Select Defense & Aerospace Fund (FSDAX). http://finance.yahoo.com/q/pr?s=FSDAX This no-load fund holds all the major military suppliers in its portfolio including United Technologies, Boeing, Lockheed Martin, General Dynamics, Northrop Grumman, Raytheon, and Rockwell - to name only a few.

Investors who might prefer a more direct defense investment should consider Raytheon (RTN), a major producer of sophisticated command and control electronics, guidance systems, and related equipment. http://finance.yahoo.com/q/pr?s=RTN Raytheon supplies all branches of the U.S. military with systems that are years ahead of what is available elsewhere.

Some readers may worry that the defense industry might only do well if Senator McCain wins the presidency. However, there is little doubt that Senator Obama will also support rebuilding our military. Maintaining a strong national defense is part of both Republican and Democratic platforms.

In A Low Yield World, Dividends Shine

One of the most frustrating problems investors face today is trying to get a decent return on their cash. The outlook for relief anytime soon is poor because the Fed's expected interest rate hikes have been tabled due to the weak economy. We don't expect to see a change in that policy anytime soon.

Meanwhile, several blue chip stocks have declined so much in price that their dividend yields have become quite attractive. Of course, buying high-yielding stocks makes no sense if the company's financials are so weak that the dividends may be cut.

Fortunately, several firms with good yields are likely to hold their dividends steady. A few of them may actually raise their payouts to attract investors. Among the latter, General Electric (GE) looks especially promising. http://finance.yahoo.com/q/pr?s=GE

GE is in the bargain basement primarily because it has a substantial financial service operation that isn't doing well. However, investors are overlooking GE's much larger industrial strengths. The company makes everything from locomotives to wind turbines, all of which are high-margin items that are sold worldwide. Thanks to its industrial operations, the company has an AAA bond rating.

GE is currently paying an attractive 4.20% dividend. Not only is the dividend unlikely to be cut, several analysts think the company may raise it later this year.

As much as we like GE's yield, it is the potential stock appreciation that we find most appealing. Although GE made some mistakes in the past, and is saddled with a financial service operation, the company is a multinational powerhouse. When global economic conditions improve, we think GE will be a top performer.

Another company we like very much is Kraft Foods (KFT), one of the world's leading food and beverage suppliers. http://finance.yahoo.com/q/pr?s=KFT Although the company's 3.30% yield is lower than you can get with GE, the company's position in a defensive industry is appealing. That's one of the reasons that Warren Buffett of Berkshire Hathaway purchased 10% of the company.

Kraft is currently out of favor on Wall Street because the company's profits have been hurt by soaring oil prices that pushed food costs sharply up. However, with energy prices coming down, Kraft's costs should soon begin to drop. In any event, the company is finally starting to pass its higher costs onto consumers.

Thanks to the new policy, Kraft's second quarter profit rose from $707 million to $735 million. With some 80 new products on the way, the company should be on track for another good year.

The Bottom Line This Week

Higher inflation numbers from July, plus the Russia/Georgia conflict, appear to have put the summer rally on hold. However, lower oil prices and a stronger dollar should get it going again. The near term aside, investors with an eye to both dividends and capital appreciation should profit from adding General Electric and Kraft Foods to their portfolios.

Until Next Week

The AIA "Advocate For Absolute Returns", a weekly publication of The Association for Investor Awareness, Inc., tracks market trends, industry news, the SEC, global trade and finance and Washington developments for you because they affect your investments. But who doesn't? Many sources report these issues as abstract facts. We feel that's not enough. The AIA Advocate's job is to warn you of what's important and how these developments translate to ground-level forces and threats that directly affect your wealth as well as your current investment opportunities. Not just information, but information you can use. Until next Thursday...