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Introduction

After the United States Presidential election, equity markets were hammered. Further, companies reporting third-quarter earnings delivered less than impressive results and many have been guiding lower for the fourth quarter and fiscal year 2013. Add to this the proverbial "fiscal cliff" on every investor's mind, which has the potential to negatively impact everyone in the United States simultaneously, and there is major cause for concern. The fear of going over this devastating fiscal cliff has exerted much pressure on markets that many believe were only propped up by central bank actions in the months leading up to the election. However, in this past two weeks of trading, the markets have rebounded a bit higher on some positive rhetoric out of Washington that both Democrats and Republicans want to avert the cliff and the hope that they will do so. I believe the markets will continue to trade on news out of Washington for the remainder of the year in addition to trading on major economic news. It is more than likely that markets will trade up on days where progress on a fiscal cliff resolution is seemingly made, and trade down when it seems negotiations are failing and move minimally or trade flat in between.

Most investors, including this author, do not believe that markets will trade flat come the fiscal cliff deadline. If we go over the cliff, investors may want to consider taking some bearish action should market panic ensue. Bearish conditions could lead investors to consider selling stock, selling covered calls on their positions, shorting stocks, buying puts or investing in a bear fund. If we have a resolution, it will most likely (depending on the terms of the resolution of course) be one of the most significant risk-on events in the last few years. In this case, bullish investors will be buying stocks and ETFs, selling puts, buying call options etc. While each of these approaches in a bearish or bullish scenario has their respective benefits and risks, in this article, I want to highlight six ETFs for a bullish fiscal cliff outcome and four ETFs for a bearish fiscal cliff outcome.

A fiscal cliff resolution: risk-on event

For low-risk investors

Conservative investors can consider buying large capitalization blue-chip stocks or one of the following two basic index funds that will be a profitable and low-risk approach if the fiscal cliff is resolved. While virtually all investors are aware that there are funds that track the Dow Jones Industrial and the S&P 500 indices, many investors still have not considered simply buying total market exposure through one of these funds to track the averages. They are not considered an elegant or clever investment by any means, nor do they offer the most profit potential, but the fact is that they do indeed work in bullish markets. They pay a dividend too, which if reinvested by the conservative buy and hold investor, can compound gains for years to come.

SPDR Dow Jones Industrial Average (DIA): This fund boasts $10.32 billion in assets and was started in 1998. The investment fund seeks to replicate, before fees and expenses, the Dow Jones Industrial Average. The portfolio consists of as many of the index securities as is practicable to replicate the performance of the Dow. To maintain the correspondence between the composition and weightings of stocks held by the trust and component stocks of the DJIA, the fund's management is required to adjust the composition of the portfolio whenever there is a change in the identity of any index security within three business days before or after the day on which the change is scheduled to take effect. Thus, there is not perfect alignment of the Dow and DIA, but it is nearly perfectly correlated. The annual expense ratio of the fund is a paltry 0.17%. The DIA also pays a fluctuating monthly dividend, and based on the last distribution of 32 cents, yields 2.5% annually. The fund currently trades at $130.74 with a 13 p/e ratio. On average approximately 5.5 million shares exchange hands daily. DIA has a 52-week range of $117.05-$136.47 and is up 0.7% in the last week. Conservative investors can consider buying this fund to track the gains that will be had in the Dow Jones stocks should the fiscal cliff be resolved.

SPDR S&P 500 Index Fund (SPY): This fund started in 1993 and is about 10 times the size of the DIA, with over $109 billion in assets, offers more diversification than the DIA. As the name implies, this fund seeks to provide investment results that, before fees and expenses, corresponds to the price and yield performance of the S&P 500 Index. To maintain the correspondence between the composition and weightings of the portfolio's securities and the component stocks of the S&P 500 Index securities, the fund's management adjusts the portfolio from time to time to conform to periodic changes in the identity and/or relative weightings of index securities. Thus, the fund does not track the S&P 500 index exactly, but is nearly perfectly correlated. Further, the expense ratio is very small, even less than that of the DIA, at 0.09%. The SPY currently trades at $141.98 with a 14 p/e ratio, has a 52-week range of $120.03-$148.11 and is down 0.2% in the last week. On average, approximately 134.2 million shares exchange hands daily. SPY yields 2.0% annually based on the last dividend paid. Conservative investors who want to have broader exposure to the overall market can consider buying this fund to track the gains that will be had in the S&P 500 stocks should the fiscal cliff be resolved.

For investors willing to take on more risk

Investors who are willing to take on more risk can always buy into some smaller cap individual stocks. They can also dabble in buying call options or selling put options to ignite gains should they be correct about the market's movements. Another approach, as not all investors understand or have the ability to work with options, is to pick up some leveraged ETFs. These funds often have a portfolio that attempts to match underlying index performances by a multiple of two or even three in some cases. These funds are not to be held for the long term though as they often have high expenses associated with them and can degrade rapidly in a bearish market. However, should the fiscal cliff see a resolution, these two funds will be extremely well placed to provide significant returns.

Proshares Ultra Dow 30 (DDM): Like the DIA, the DDM tracks and replicates the Dow. However, DDM seeks daily investment results, before fees and expenses, that correspond to two times the daily performance of the Dow. The fund invests in securities and derivatives that the management (ProShares Advisors) believes, in combination, should have similar daily return characteristics as two times the daily return of the Dow Jones Industrial Average. DDM has a much higher expense ratio than DIA, over five times as high in fact at 0.95%. DDM currently trades at $70.30 a share on average daily volume of 394,000 shares. The fund has approximately $200 million in assets. The fund has a 52-week range of $55.41-$76.30 and is up 0.9% in the last week. Should the fiscal cliff be resolved and we see a major risk-on event, this fund's share price will likely appreciate rapidly.

ProShares Ultra S&P 500 (SSO): Like the SPY, the SSO attempts to replicate the performance of the S&P 500. In contrast to the SPY, the SSO is leveraged in that it seeks to magnify the returns generated by the S&P 500 stocks. The SSO seeks daily investment results that correspond to twice the daily performance of the S&P 500 index. The fund invests in securities and derivatives that the management team (ProShares Advisors) believes, in combination, should have similar daily return characteristics as twice the daily return of the index. The SSO has a much higher expense ratio than the SPY, 10 times as high in fact, at 0.91% annually. Despite the long-term detriment of high expenses, the fund performs exceptionally well during bull markets. SSO currently trades at $59.17 a share on average daily volume of 6.7 million shares. It has a p/e ratio of 14 and pays a small annual yield of 0.55% based on its last distribution. Finally, the fund has a 52-week range of $42.45-$64.27 and is down 0.4% in the last week.

Direxion Large Cap Bull 3X Shares (NYSEARCA:SPXL): This is a leveraged way to play a short-term risk-on situation and could provide immense returns with the resolution of the fiscal cliff. SPXL seeks daily investment results, before fees and expenses, of 300% of the price performance of the S&P 500 Index. The fund normally creates long positions by investing at least 80% of its net assets in the equity securities that comprise the index and/or financial instruments that provide leveraged and unleveraged exposure to the index. The fund has an expense ratio of 0.95%. Given the goal of daily performance coupled with the expense ratio, SPXL (like DDM and SSO) should not be held long term, but does well when holding for the short-term during bull markets. SPXL currently trades at $85.46 on average daily volume of 722,000 shares. The fund has a 14 p/e ratio and has over $169 million in assets. Finally, SPXL has 52-week range of $53.29-$96.83 and is down 0.4% in the last week.

Direxion Small Cap Bull 3x Shares (TNA): This is my favorite way to play a short-term risk-on situation, as the gains are so outsized on this leveraged ETF when your buy is timed properly. I think a fiscal cliff resolution would be an opportunity to take this risk, as the reward could be tremendous in a short period of time. This investment fund seeks daily investment results, before fees and expenses, of 300% of the performance of the Russell 2000 Index. The Russell 2000 index measures the performance of the small-cap segment of the U.S. equity universe and is comprised of the smallest 2000 companies in the Russell 3000 Index. As an FYI, the most common way to trade the Russell 2000 is through the iShares Russell 2000 (NYSEARCA:IWM). TNA, under normal circumstances, creates long positions by investing at least 80% of its net assets in the equity securities that comprise the index and/or financial instruments that provide leveraged and unleveraged exposure to the Russell 2000 index. The fund has an expense ratio of 0.95%. Given the goal of daily performance coupled with the expense ratio, TNA (like SPXL, DDM and SSO) should not be held long-term, but does well in short and medium holding times during bull markets. TNA currently trades at $57.75 on average daily volume of 9.5 million shares. The fund has a 16 p/e ratio and has over $738 million in assets. Finally, TNA has 52-week range of $38.97-$68.98 and is down 0.6% in the last week.

If fiscal cliff negotiations fail, spending cuts and tax hikes go into effect: risk off event

There will be a massive correction if we go over the cliff. The conservative investor will have little choice but to sell equities and sit in cash or risk holding and waiting weeks, months or possibly even years for the rebound. This is only wise with a diversified, high-yield portfolio and even then portfolio growth will be missed by sitting idle. Investors willing to take on more risk can buy puts, sell calls or straight out short stocks. For those who cannot or will not take this approach, there are bear funds that exist, both leveraged and unleveraged, which can protect capital in bear markets. In order of risk based on degree of leverage and underlying indices replicated, I highlight four bearish ETFs that will provide outsized returns should we plunge over the cliff.

ProShares Short S&P 500 (SH): This ETF seeks daily investment results that correspond to the inverse of the daily performance of the S&P 500 index. The S&P 500 index is a measure of large-cap United States stock performance. It is a capitalization weighted index of 500 United States operating companies and selected real estate investment trusts. SH attempts to invest at least 80% of its net assets, including any borrowings for investment purposes, to investments that, in combination, have economic characteristics that are inverse to those of the index. It intends to invest assets not invested in financial instruments, in debt instruments and/or money market instruments. The fund intends to concentrate its investments in a particular industry or group of industries to approximately the same extent the underlying index is concentrated. SH currently trades at $34.41 on approximately 3.3 million shares exchanging hands daily. SH is up 0.1% in the last week, while the S&P 500, as measured by the SPY is also up by 0.4%. SH has a 52-week range of $33.33-$42.37.

ProShares UltraShort S&P 500 (SDS): This leveraged fund seeks daily investment results that correspond to twice the inverse of the daily performance of the S&P 500. SDS invests in common stock issued by public companies. SDS also invests in derivatives, which are financial instruments whose value is derived from the value of an underlying asset, interest rate or index. SDS recently underwent a one-for-four reverse split. It currently trades at $55.33 a share. SDS has average daily volume of 8.2 million shares exchanging hands. In the last week, SDS is up 0.2%, while the SPY is up 0.4%. SDS has a 52-week range of $52.12-$84.88.

Direxion Daily S&P 500 Bear 3x ETF (SPXS): SPXS, formerly the Direxion Daily Large Cap Bear 3X fund, seeks daily investment results before fees and expenses of 300% of the inverse of the price performance of the S&P 500 Index. As with other funds, there is no guarantee the fund will meet its stated investment objective. The fund has a 1.14% annual expense ratio. Under normal circumstances, SPXS management creates short positions by investing at least 80% of its net assets in: futures contracts; options on securities, indices and futures contracts; equity caps, collars and floors; swap agreements; forward contracts; short positions; reverse repurchase agreements; ETFs; and other financial instruments that, in combination, provide leveraged and unleveraged exposure to the S&P 500. SPXS currently trades at $17.58 a share. SPXS has average daily volume of 1.9 million shares exchanging hands. In the last week, SPXS is up 0.5%, while the SPY is up 0.4%. SPXS has a 52-week trading range of $16.07-$34.17.

Direxion Daily Small Cap Bear 3X Shares (TZA): This is my favorite way to invest in a bear market short term. TZA seeks daily investment results of 300% of the inverse of the price performance of the Russell 2000 Index (also known as the small cap index). The Russell 2000 measures the performance of the small-cap segment of the United States equity universe and consists of the smallest 2,000 companies in the Russell 3000 Index, representing approximately 10% of the total market capitalization of the Russell 3000 Index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.

TZA actually does not invest in equity securities or stocks. What TZA does is creates short positions by investing at least 80% of its net assets in financial instruments to provide leveraged and unleveraged exposure to the small cap index and the remainder in money market instruments. TZA currently trades at $15.14 a share on average daily volume of 18.8 million shares. In the last week, TZA is up 0.4% compared with IWM, which is down 0.2%. TZA has a 52-week range of $13.35-$31.40.

Conclusion

Many approaches exist to position accordingly for a risk-on event, or in contrast, market panic. While central bank action had once bolstered markets, mediocre earnings reports, turmoil in Europe, the United States Presidential election outcome and now the looming fiscal cliff will continue to dictate the direction of equities markets. If fiscal cliff negotiations fail, the aforementioned bearish funds will perform very well in response to the market panic that will ensure. This is especially true if we head over the cliff without even a short-term fix in place. Should the politicians in Washington pull together and get something done to resolve the fiscal cliff debacle, we will see a major risk-on event. In either case, investors can indeed profit by considering one of the aforementioned funds once there is clarity on a resolution of the fiscal cliff, or a lack thereof.

Disclaimer: I am not recommending investors to be bullish, bearish or neutral. This article is for informational purposes only and highlights funds one can consider in response to one of two fiscal cliff outcomes. It is not a recommendation to buy or sell any of the aforementioned assets or to position one way or the other ahead of the fiscal cliff deadline. Rather it is a recommendation to consider these funds in the immediate aftermath of a major risk-on or significant sell-off event, in addition to the myriad of other options to position a portfolio accordingly, as discussed above.

Source: 10 Ways You Can Profit From The Fiscal Cliff