One of the most used market buzz terms in recent months has
been "fiscal cliff." That is the ominous scenario in which tax
cuts expire and are met with tax increases and spending
reductions. While it has been painfully obvious for years that
Uncle Sam needs to spend less money, the spending cuts could be
muted by the fiscal cliff's other issues.
Positive momentum gained from spending reductions will take a
while to have a material impact on the broader economy and that
ebullience will almost certainly be initially thwarted by the
negativity that comes with the expiration of tax cuts and the
introduction of tax hikes.
Or if one chooses to explain the concept of the fiscal cliff
to a second-grader, the adjectives awful, bad and terrible will
suffice. If the fiscal cliff is not addressed by the end of the
year, the U.S. could
lose $600 billion in economic output
, enough to send the world's largest economy back into a
Hopefully, that will not happen, but if the fiscal cliff does
come to pass, these ETFs could be in for some selling
Consumer Discretionary Select Sector SPDR (NYSE:
Marquee U.S. economic data points have been volatile to say the
least in 2012. One batch is encouraging while another is
concerning and that pattern has repeated itself throughout the
year. Still, the U.S. consumer has been surprisingly resilient,
enabling discretionary ETFs such as XLY to
stellar year-to-date returns
XLY, the largest discretionary ETF, is up 19 percent while the
SPDR S&P Retail ETF (NYSE:
) is up 18.1 percent. The Market Vectors Retail ETF (NYSE:
) has gained over 21 percent. This trio and rival funds are
vulnerable in a fiscal cliff scenario, though.
A $600 billion hit to GDP
is roughly four percent
of total U.S. economic output. Combine that with the fact that
the U.S. consumer is the single most important driver of GDP and
it is easy to see why discretionary and retail ETFs could falter
if the fiscal cliff is not avoided.
iShares Dow Jones U.S. Aerospace & Defense Index Fund
Or the PowerShares Aerospace & Defense Portfolio (NYSE:
). Things could change after Election Day, but at the moment,
there appears to be some bipartisan support for reducing defense
spending. Lower defense spending is not a good thing for ETFs
that hold stocks like Boeing (NYSE:
), Lockheed Martin (NYSE:
) and General Dynamics (NYSE:
), which ITA and PPA do.
ITA and PPA are up eight percent and 10.3 percent,
respectively, this year. That sounds good, but the returns are
somewhat ominous when considering the S&P is up nearly 14
iShares iBoxx $ High Yield Corporate Bond Fund (NYSE:
Or the SPDR Barclays Capital High Yield Bond ETF (NYSE:
). The two largest junk bond ETFs combine for over $29.2 billion
in assets under management. HYG, JNK and comparable funds have
been prime beneficiaries of the Federal Reserve's low interest
rate policies, which has arguably forced investors to take on
more risk in order to gain yield.
While junk bond ETFs have performed well this year, there have
been signs as of late
the group is ready for a pullback
and some analysts have cautioned chasing capital appreciation in
these ETFs at current levels is risky.
Add to that the likelihood the fiscal cliff will take a bit of
risk appetite and send bond investors running to investment grade
fare, and HYG and JNK look vulnerable, too.
PowerShares DB Base Metals Fund (NYSE:
The PowerShares DB Base Metals Fund does not grab a lot of press,
though it should be noted the fund is by no means small or thinly
traded. DBB has $328.6 million in AUM and average daily volume of
almost 226,350 shares.
This is the problem with DBB assuming the fiscal cliff
arrives. The fund is evenly divided among aluminum, copper and
zinc futures contracts. Simply put, demand for those metals will
suffer in a recession, plaguing DBB in the process.
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