It is out there looming, stalking, waiting to pounce. It being the fiscal cliff, the highly undesirable situation under which expiring tax cuts are not renewed (in essence becoming tax hikes) and are met with spending reductions by the affected government.
The U.S. is facing such a scenario and the result could be the loss of $600 billion, or four percent of GDP. More than a few analysts believe that type of haircut will be enough to send the world’s largest economy tumbling to another recession. The spending reductions could be a long-term positive, but the impact of those cuts will be muted in the near-term as markets and investors react to the loss of stimulative tax cuts.
Not surprisingly, plenty of ETFs could prove vulnerable to the fiscal cliff. From discretionary and retail ETFs to funds tracking sectors highly dependent on government spending to those offering exposure to industrial commodities, there is no shortage of ETFs that could be hit by the fiscal cliff.
This is one of those times when failure to prepare is preparing to fail. With that old adage in mind, here are some ETFs investors can use to weather the fiscal’s cliff storm.
PowerShares Exchange-Traded Fund Trust II (NYSEARCA:SPLV) It is safe to say that any region, sector or theme that is or is perceived to be high on beta and volatility will be savagely repudiated due to the fiscal cliff. Moving the opposite direction from high volatility ETFs, investors can find their way to SPLV, the the king of the low volatility ETF arena.
The fiscal cliff also has the potential to pressure those sectors that are highly correlated to the broader market’s whims, so it would behoove investors to pass on those groups. Fortunately, SPLV devotes a combined 60 percent of its weight to consumer staples and utilities names and those two sectors are among the least correlated to the S&P 500.
iShares IBoxx $ Invest Grade Corp Bd Fd (NYSEARCA:LQD) One obvious impact of the fiscal cliff is that it will likely erode risk appetite, spelling bad news for junk bond ETFs in the process. While desire for yield may not diminish much during the fiscal cliff, risk appetite certainly will. That would hamper gains for junk bond ETFs, an asset class where some would argue the easy money has already been made.
Bond investors looking for the combination of conservative positions and yields above what Treasuries offer could be all but forced to consider high-grade corporates. LQD’s 30-day SEC yield is just 2.76 percent, but income investors can find some level of comfort in this ETF because it does pay a monthly dividend.
PowerShares Emerging Markets Sovere (NYSEARCA:PCY) Some so-called experts have argued that amazing ascent of the PowerShares Emerging Markets Sovereign Debt Portfolio and rival funds such as the iShares JPMorgan USD Emer Mkt Bnd Fd (NYSEARCA:EMB) in 2012 has been fueled by the Fed’s low interest rate policy, which has encouraged higher risk appetite.
That argument is easily refuted by the fact that PCY’s holdings are dollar-denominated and quantitative easing is seen as damaging to the dollar. Rather, improving emerging markets balance sheets and credit ratings have boosted PCY, and that is a scenario that can continue regardless of the fiscal cliff happening in the U.S. Over the past three years, PCY’s correlation to the S&P 500 is just 0.68.
Those wanting to part ways with the dollar can opt for the WisdomTree Trust (NYSEARCA:ELD). That actively managed product’s holdings are denominated in local currencies.
This article was originally written by The ETF Professor, and posted on Benzinga.