These ETFs May Rally If Fiscal Cliff Deal Is Reached

 |  Includes: DIA, EEM, SPY, VAW, VWO, XLI
by: Tom Lydon

New money continues to flow into U.S. equity exchange traded funds during the final month of 2012. With the impending fiscal cliff less than one month away, investors are prepared to put more capital into certain sectors should a deal be reached.

"With the outcomes of the US elections and super storm Sandy known and a growing sense that a solution to the looming fiscal cliff will be negotiated, investors put $20.6 billion into US-listed exchange traded funds and products in November," said Deborah Fuhr, managing partner at ETFGI, the consultancy.

High yield investments such as bank loans and emerging market debt continue to take in inflows while the high yield fixed-income ETF flows turned negative and investment grade corporate bond inflows subsided, reports Chris Flood for the Financial Times.

Investors are hopeful that Congress and the Obama Administration can reach a deal before Bush-era tax cuts expire next month. Prevention of automatic spending cuts and higher taxes across the board will help get the wheels of the U.S. economy spinning faster, and keep the following sectors on an upward trend:

  • Broad-based U.S. equity ETFs such as the SPDR S&P 500 (NYSEARCA:SPY) and the SPDR Dow Jones Industrial Average (NYSEARCA:DIA) would benefit from a removal of fiscal cliff fears. Analysts are remaining bullish on the outlook for the stock market next year, and amid the low growth and low interest rates, equities are cheap. David Kotok, chairman and chief investment officer at Cumberland Advisors in Sarasota says stocks are cheap and sees the S&P 500 reaching 1,450 to 1,550 by year's end, translating to 145.00 to 155.00 a share for SPY, up 2% to 9% from current levels. The S&P's 2% dividend yield outweighs the risk-free 10-year Treasury note yields of 1.6%.
  • Once an agreement is made and the fiscal cliff averted, a "risk-on" attitude will take over for investors. Emerging market plays such as iShares MSCI Emerging Markets (NYSEARCA:EEM) or the Vanguard Emerging Markets (NYSEARCA:VWO) would take in more inflows. Let's face it, a busy U.S. economy can only help emerging economies. According to GMO, a Boston-based money management firm, emerging markets' stocks are forecast to grow 6.3% annually over the next seven years, compared to 4.8% for U.S. high-quality stocks, reports John Wasik for Reuters.
  • More growth overseas, and domestic, equals better performance for materials and industrials, two sectors that practically disappeared this year. A low-growth, yet sustainable recovery will favor employment and individual wealth, which leads to big ticket items rising in demand. Household appliances, cars and consumer item sales will pick up and create a need at the base of production and manufacturing. The SPDR Industrial Select Sector Fund (NYSEARCA:XLI) and the Vanguard Materials ETF (NYSEARCA:VAW) would have room to rally and make headlines again.

SPDR S&P 500

Click to enlargeTisha Guerrero contributed to this article.

Full disclosure: Tom Lydon's clients own SPY and EEM.

Disclosure: I am long SPY, EEM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.