Market Overview

4 ETFs for a Fiscal Cliff (ERY, SDY, UUP)


As if the already fragile U.S. economy does not have enough issues to deal with already, there is the looming specter of a so-called fiscal cliff: the scenario under which some dire fiscal issues could come to roost.

Among other issues, the fiscal cliff would consist of the Bush-era tax cuts from 2001 and 2003 (including the dividend tax reduction) expiring, the alternative minimum tax applying to more taxpayers and a major increase in payroll taxes in 2013.

J.P. Morgan has estimated $280 billion would be sapped from the economy if the Bush tax cuts expire. Bank of America economists say the ensuing economic drag at the hands of the fiscal cliff could be as high as $720 billion, or 4.6 percent of U.S. GDP.

Morgan Stanley's analysis is even more dire. "Our analysis suggests that the potential fiscal tightening in calendar year 2013 under current law is closer to 5% of GDP," the bank said.

Assuming the folks on Capitol Hill can get their acts together and a fiscal cliff is avoided, plenty of ETFs stand to benefit. Conversely, if the worst-case scenario plays out, there is no shortage of ETFs that could be savagely repudiated. Here are a few ideas for both situations:

SPDR S&P Dividend ETF (NYSE: SDY) Really, any dividend ETF would do in this spot. If the Bush tax cuts expire, the tax rate on dividends would jump to 20 percent from 15 percent. Amid intense efforts by dividend-paying firms, it appears Senate Democrats are taking a softer stance on the dividend tax issue and some compromise could come to pass Reuters reported Monday.

President Obama has proposed raising the dividend tax to 20 percent from 15 percent on those earning more than $250,000 a year, but that is not necessarily the point. The point is dividends are a key driver of returns for most investors, regardless of their income.

Even speculation that some companies could halt dividend increases, in turn hurting retirees, if the Bush tax cuts are not extended, might be enough to get politicians to compromise on this issue. After all, politicians have one priority: Keeping their jobs.

The bottom line is SDY, the Vanguard Dividend Appreciation ETF (NYSE: VIG), the iShares Dow Jones Select Dividend Index Fund (NYSE: DVY) and related fare may not rally if the fiscal cliff does not happen. However, those funds could easily falter if the dividend tax cuts are allowed to expire.

ProShares UltraShort Consumer Services (NYSE: SCC) The ProShares UltraShort Consumer Services, the double-leveraged inverse equivalent of the iShares Dow Jones U.S. Consumer Services Sector Index Fund (NYSE: IYC), will not win any volume contests with average daily turnover of just about 2,600 shares. However, it could be a winner in terms of performance if the fiscal cliff comes to pass.

Like many discretionary ETFs, the iShares Dow Jones U.S. Consumer Services Sector Index Fund has is home to a few stocks that have the potential to be less bad in a recession. Costco (NASDAQ: COST) and Target (NYSE: TGT) come to mind. However, IYC and other large discretionary ETFs also features stocks such as Amazon (NASDAQ: AMZN), eBay (NASDAQ: EBAY) and Walt Disney (NYSE: DIS).

Those are not recession-proof names. Those are names that are heavily dependent on consumer spending. The consumer accounts for two-thirds of U.S. GDP. U.S. GDP is expected to fall under the fiscal cliff scenario. Do the math and things do not look good for discretionary ETFs and that is good for an ETF such as SCC.

Direxion Daily Energy Bear 3X Shares (NYSE: ERY) With the Congressional Budget Office and almost every bank that has commented on the matter saying the fiscal cliff would throw the U.S. into another recession, that would be grim news for oil prices. The U.S. is still the world's largest oil consumer and is three percent, five percent or more of GDP is slashed due to the fiscal cliff, oil equities and futures will plunge.

Under that scenario, there is almost no way the broader market will hold up because the energy currently accounts for almost 11 percent of the S&P 500's weight.

The reality is no base metal or fossil fuel is likely to shine if the fiscal cliff comes around and that will pressure almost all of the commodities complex. Regarding equities, the declines for the likes of Exxon Mobil (NYSE: XOM), Apache (NYSE: APA) and Schlumberger (NYSE: SLB) would be dramatic. All are top-10 holdings in the Energy Select SPDR (NYSE: XLE), which tracks the S&P Energy Select Sector Index. That is the same index ERY is designed to deliver three times the daily inverse performance of.

PowerShares DB US Dollar Index Bullish (NYSE: UUP) Recessions have predictable affects. One of those affects is spurring a flight to quality and in this case, that means investors will be left with few safe havens beyond the U.S. dollar. In a recession, U.S. demand for imported goods declines, boosting the dollar in the process. Not to mention, the fiscal cliff could trigger up to $600 billion in government spending cuts, a catalyst that could increase the allure of greenbacks..

Posted-In: Long Ideas News Sector ETFs Broad U.S. Equity ETFs Short Ideas Dividends Commodities Currency ETFs Best of Benzinga


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