The victory by the Republicans to take over control of the U.S. House of Representatives could turn out to be a game-changer for several sector ETFs in the U.S. Now that Washington, D.C. is split, it will be tougher for the Democrats to push through some of their initiatives.
That means investments in an array of industries, including defense, health care, energy and financial services could get a shot in the arm in the wake of the changes coming to the nation's capital next year.
But remember, even though I think there are good tactical reasons to give a lot of these ETFs another look right now, I believe they'd be good investments even if the GOP weren't so revitalized by the midterm elections.
The proposed 2011 defense budget is over $700 million, and it is likely to be passed easily because the Republicans have historically been proponents of a strong military. The ongoing war in Afghanistan and against all terror organizations around the world will require large spending on military and homeland security.
I mentioned two ETFs in a recent column that give investors exposure to the defense sector. The iShares Dow Jones US Aerospace & Defense ETF (NYSEArca:ITA) and the PowerShares Aerospace & Defense ETF (NYSEArca:PPA) should benefit from the GOP win and eventual passing of the defense budget.
Both ETFs are considered longer-term plays on defense spending, and the fact that the U.S. sees no end in sight to the war on terror makes a long-term buy-and-hold approach sensible. In the week following the election results, the two ETFs gained over 1.5 percent, though they lagged the overall performance of the U.S. stock market.
Anyone who has picked up a paper or turned on a television in the last year knows the Republicans were against the Obama administration's health care reform. Now that the GOP has control of the House, there will be a greater push to repeal the bill or, at a minimum, alter it. Two ETFs in the sector that could benefit from a watered-down health care bill or a total repeal would be the Vanguard Health Care ETF (NYSEArca:VHT) and the SPDR Select Sector Health Care ETF (NYSEArca:XLV).
Even with the Republican win, the two ETFs have struggled since the results from the Nov. 2 elections came in. Investors must realize the only true boost from the election for the health care ETFs will occur if there is a major change to the current health care bill. Without a change or repeal, the sector is on its own.
The Democrats are known as the party that favors an environmentally friendly "green" agenda, and the Republicans back old-school fossil fuels as an energy source. Granted these are broad generalizations, but there's a grain of truth in the stereotypes. The Democrats have been trying to push the cap-and-trade bill that would hurt industries such as coal and benefit the green energy companies.
The big winner from the Republican takeover of the House of Representatives is the Market Vectors Coal ETF (NYSEArca:KOL). The ETF is composed of a basket of coal stocks, and has risen over 7 percent in the week after the election.
Most of the energy-related ETFs have also posted big gains, with the SPDR Select Sector Energy ETF (NYSEArca:XLE) up over 4 percent and the First Trust ISE Natural Gas ETF (NYSEArca:FCG) rallying nearly 5 percent. Both ETFs are composed of a basket of stocks in their related sectors.
The Democrat-backed financial industry reform bill has already been passed; however, the future oversight of the industry may not be as tough thanks to the Republican win. Neither side of the aisle wants to be on bad terms with Wall Street, but it is most investors' opinion that the GOP tends to favor big business and investment bankers a bit more than the Democrats.
The SPDR Select Sector Financial ETF (NYSEArca:XLF), a basket of large banks and brokerages, is up 6 percent since the election and at a new five-month high. The iShares Dow Jones U.S. Broker-Dealers Index Fund (NYSEArca:IAI) also rallied to a new multimonth high after the election, and is up 4 percent in the last week.
The Bush tax cuts are set to expire at the end of the year and Obama doesn't appear to be ready to back down and extend them into 2011 or beyond.
Most Republicans are for extending the tax cuts, and it's possible the election results will sway the president over to the other side of the aisle on this major decision. If Obama chooses to extend the tax cuts, it will keep the tax rate on dividends at the current rate and boost the dividend-paying stocks.
The SPDR S&P Dividend ETF (NYSEArca:SDY) and the iShares Dow Jones Select Dividend Index Fund (NYSEArca:DVY) are two ETFs that concentrate on investing in large-cap, high-dividend-paying stocks. Both have lagged the overall market since the election, but once again, this is a longer-term bet on the Bush tax cuts not being repealed.
Several of the sectors mentioned will only benefit if certain situations go in their favor. That's the risk you take.
That said, I would only recommend buying the above-mentioned ETFs if I believed in them for reasons other than the election. The election simply increases the odds of picking a winning investment.
Matthew D. McCall is editor of The ETF Bulletin andpresident of Penn Financial Group LLC, a Ridgewood, N.J.-based wealth management firm specializing in investment strategies using ETFs.
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