There are two main problems. The first is the risk that emerging nations like China, which have already started raising interest rates to battle inflation, will be forced to drive their economies into the ground to keep prices in check.

The second is that the inflation hawks in Europe will shift their focus from bailouts to fighting inflation -- thereby tightening the noose around Greece, Ireland and Portugal and setting the stage for the first rich-country debt default since the 1940s. Tighter monetary policy and interest rate hikes will result in unsustainably high borrowing costs for those countries.

Blame the chain

Setting aside the problems with emerging markets and Europe, corporate America faces the prospect of reduced profit margins as higher inflation brings both cost increases and reductions in consumer demand. Right now, according to Credit Suisse researchers, cost inflation on such things as raw materials and labor wages is at the lowest level since tracking started in 1961.

But those costs are now set to move higher. And as they do, they will put pressure on earnings growth. That, in turn, will weigh on stock valuations and prices. Throw in the pressures from a likely eurozone bond default and the potential for a slowdown in China, and the stage is set for a meaningful correction in risky assets like stocks and industrial commodities.

The problem is that higher inflation is pretty much baked into the cake at this point. Deutsche Bank economist Joseph LaVorgna reminds us that inflation is a lagging economic indicator. Last summer's deflation scare was an echo of the sharp drop in economic activity from the beginning of 2008 to the middle of 2009. In the past, inflation has bottomed six to eight quarters after a recession has ended. That means prices should hit bottom and start turning higher sometime between now and the end of June.

Also, the inflation "pipeline" is fully stocked, with both import and producer prices rising much faster than consumer prices. In December, import prices jumped at a 4.8% annual rate, compared with a 1.4% rise in consumer prices. LaVorgna finds that both "exhibit a significant lead on consumer prices, particularly those for core consumer goods."

Time to prepare

So what can investors do in this environment?

My appeals to avoid bonds and cash while moving toward stocks still stand. Yes, risky assets of all types likely will suffer losses in the weeks to come as investors react to the increase in prices and the resultant withdrawal of ultra-cheap central bank financing. Nevertheless, equities are still the preferred investment at this point in the business cycle, offering protection against inflation, unlike bonds.

Image: Rising Inflation © MSN Money

You can see this in the chart above -- which compares the performance of stocks to bonds during the time of rising interest rates and inflation from the early 1950s to the early 1980s. Inflation rose from negative territory to a high of 14.8% over the period. Stocks outperformed bonds by a huge margin.

Image: Falling Inflation © MSN Money

Compare that with what happened during the falling inflation/falling rate period from the early 1980s to the mid-1990s, as shown in the chart above. Inflation fell from its high to just 2.7% in the period. Clearly, the performance disparity between the returns to stocks and bonds was much smaller. In fact, for a time in 2009 (not shown in the chart), the cumulative return to bonds over the period actually exceeded that of stocks as the inflation rate went negative again, pushing bond prices higher.

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That helps explains the recent obsession with bonds among retail investors -- along with the fact that stocks are exiting their worst 10-year performance since the 1930s.

So if you've been sitting on the sidelines, use the turmoil ahead to transition out of bonds and into stocks at a discount -- and avoid the next great 401k wipeout I warned about last week once the specter of inflation passes and Europe addresses its structural issues in a comprehensive way . Sure, there will be setbacks and volatility. But above all else, being in the right asset class will help you create wealth in the decades to come.

Be sure to check out Anthony's new money management service, Mirhaydari Capital Management, and his investment newsletter, the Edge. A free, two-week trial subscription to the newsletter has been extended to MSN Money readers. Click here to sign up. Mirhaydari can be contacted at and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.