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How to Trade the End of 'QE2': Strategists

NEW YORK (TheStreet) -- Quantitative easing, which has kept yields on bonds artificially low and has investors flocking to risky assets such as stocks and commodities, is widely expected to end in June.

But market analysts say investors should continue to bet on stocks and commodities even after the Federal Reserve ends its $600 billion bond-buying program -- known as QE2 -- as bonds will prove to be an unsafe alternative.

A combination of recovery expectations, inflation risks and worries about the massive federal deficit have been pressuring bonds and lifting yields -- bond prices and yields share an inverse relationship. But with the Fed stepping in to buy up Treasury notes, analysts say the rise in yields has been relatively modest. The intention of the Fed's purchases is to dampen interest rates, so as not to threaten an economic rebound.

However, once QE2 ends, bonds could sell off further, causing yields to climb higher. And the central bank might be forced to hike short-term interest rates eventually, as economic growth returns and inflation spikes, hurting bonds further and making them an unsafe investment for investors.

The biggest bear signal for bonds yet came last month, when Bill Gross, renowned manager of the world's largest bond fund at Pimco, exited Treasuries and increased his holdings in cash.

While rising interest rates would normally pose a threat to stocks, analysts say that is not an issue in the near term. With the federal funds rate near zero, it would take a significant monetary tightening to dim the attractiveness of stocks.

James Dailey, chief investment officer of TEAM Financial Managers, expects central banks across the world to be slow to raise rates, making commodities and commodity-related stocks a good bet even after QE2 ends.

"The damage has been done. We have seen a pickup in the inflation cycle," said Dailey. "It is not just the Fed pressing the accelerator. It is the Bank of Japan and the European Central bank. I don't think there is going to be any draconian tightening anywhere."

"Even if we see tightening, that is no reason to not own commodities," he added. "Central banks will be behind the curve. You can get corrections based on it being overbought now but the fundamentals are intact. Unless there is a global recession or one or more central banks find religion and develop a Volckeresque appetite for monetary tightening, we see negative real yields."

Dailey says he favors commodity-related stocks in the agriculture, energy and precious metals space. "Energy stocks are going nuts right now but they are still pricing in $90 oil. So even if oil plateaus at this level [ near $108 levels], those stocks are cheap."

The analyst also prefers blue-chip names that are trading at low valuations such as Microsoft (MSFT), Dell (DELL) and Hewlett-Packard (HPQ) as well as consumer companies such as Wal-Mart (WMT) and Procter & Gamble (PG) that might be better placed to pass along higher input costs.

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