Fiscal Cliff ETF Rally Still Hot

by on January 25, 2013 | ETFs Mentioned:

Almost as soon as the confetti stopped falling on election night, the popular news media began focusing almost incessantly on the fiscal cliff that would occur on December 31 of 2012. A combination of tax cut expirations and automatic spending cuts, the fiscal cliff was created by Congress as an unacceptable outcome [see Visual History Of The S&P 500]. 

Congress being Congress, there was much sound and fury, but ultimately the fiscal cliff technically occurred. Very shortly thereafter, though, Congress passed a compromise bill (which President Obama signed into law on January 2, 2013). Markets cheered on the agreement, as major benchmarks had been hinging on the fate of the situation. But some securities were able to outshine others during this period of economic rejoice. Below, we outline five ETFs that were able to cash in on the initial fiscal cliff solution [for more ETF news and analysis subscribe to our free newsletter].

SPDR S&P 500 (SPY)

Immediately after the election, the S&P 500 ETF began a 10-day plunge, losing about 4% of its value on fears of ongoing gridlock between Congress and the President. The mood soon changed on optimism about a deal to avert the cliff, and SPY shares rallied nearly 7% over the next month. About a week before Christmas, when it became increasingly apparent that a deal would not be reached in 2012, the shares reversed again for another 4% plunge. Confidence in a compromise came back again, though, and the market has rallied over 5% since December 28, 2012.

iShares MSCI Emerging Markets Index (EEM)

There has been ample debate about the medium- and long-term impact of the consequences of the fiscal cliff, but there was a general consensus that the short-term impact to the U.S. economy would be bad. Not only would that have made conditions more parlous for countries that depend on the United States for trade and economic growth, but the uncertainty created by the new path for the U.S. economy would have substantially increased risk premiums and discouraged riskier investments [see our Emerging & Frontier Markets ETFdb Portfolio].

As part of the “risk on” trade, then, emerging markets have been in good position to benefit from the resolution of the fiscal cliff (or suffer in the absence of resolution). The EEM shares rose about 5% on optimism tied to the fiscal cliff resolution, but have since weakened on worries that the United States will continue to export inflation, and that China’s recovery may be weaker than initially hoped.

Guggenheim Solar (TAN)/PowerShares Cleantech (PZD)

Alternative energy has been a large winner in the fiscal cliff process. Shares of both ETFs declined post-election on worries that various perks, credits and subsidies would vanish with the fiscal cliff, and that the weaker economy that would result would likewise be less hospitable to cleantech investments. The resolution not only resolved some of those worries, but the industry picked up unexpected benefits as well. Tax credits for wind, solar and alternate fuels were expanded and extended, and enhanced depreciation was also included in the package [see also 25 Ways To Invest In Alternative Energy].

From its lows in mid-November the Guggenheim Solar ETF has rocked almost 40%, while the PowerShares Cleantech fund has had a less robust, but still impressive, 15% growth over the last month or so.

SPDR S&P Homebuilders (XHB)

Had the fiscal cliff gone off as feared, 2013 could have been a very difficult year for homebuilders as the declines in growth would have had negative implications for employment, wage growth, and consumer confidence. That leaves the homebuilders as another group relieved to see the worst of the fiscal cliff impacts canceled (or at least delayed).

From the bottom of the post-election declines, the homebuilders ETF has seen a nearly 11% rebound (including a 4% pullback during that late December swoon as confidence of a compromise faded).

The Bottom Line

Only time will tell the ultimate winners of the fiscal cliff resolution, particularly as the cliff has yet to be fully resolved. In the short term, negotiations that stave off the worst of the bitter medicine will be supportive for stocks in general and “risk on” trades more in particular. Looking down the road, though, a failure to resolve the basic issues underlying the cliff (excessive debt and deficits and inadequate economic growth) will be bad for the dollar, bad for U.S. bonds (and stocks), and likely supportive for foreign stocks and hard assets like precious metals.

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Disclosure: No positions at time of writing.