As the Federal Reserves' $600 billion bond-buying program, dubbed QE2, comes to an end and the U.S. continues to struggle with its massive debt, investors might have to take a more defensive strategy in anticipation of higher inflation, according to a pair of four-star fund managers.
John Montgomery, manager of Bridgeway Capital Management, says inflation poses the greatest risk to investors. But there may be no way around it, he warned.
Dealing with the U.S. debt problem is "not going to happen through budget cuts, which hopefully maybe will make some impact, but inflating our way out is the only way this nation has ever done it," Montgomery told CNBC Friday.
Montgomery says his firm invests the same way in different market environments, but he's looking for investment opportunities that will be able to weather the "negative impacts" of inflation.
"The key thing here is: fixed income instruments are hugely negative impacted by inflation," Montgomery said, "Stocks tend to do a little better over the long-term." His strategy: pick stocks of companies that will be able to pass on increased costs to consumers.
Bridgeway's large-cap value fund consists of only U.S. stocks. Its current top holdings include:
Meanwhile, Doug Ramsey, co-manager of Leuthold Global Fund, expects interest rates to rise. His firm also invests in precious metalsin anticipation of higher inflation.
"We would put a number out and say CPI inflation of 4 percent by year-end. "Pipeline level inflation is running higher."
In addition, Ramsey's fund recently shorted the benchmark 10-year Treasurynote.
Ramsey expects the jobs market to experience an uptick in the second half of this year and continue into next year. Montgomery forsees the market grinding higher to reach 1450 on the S&P by the end of the year.
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Disclosure information was not available for Montgomery, Ramsey or their respective companies.