Despite a resolution to the fiscal cliff, the consequences of the budget deal will still negatively affect the markets and exchange traded funds. One iShares analyst points out some potential pitfalls and opportunities in the months ahead.
"The fiscal drag left in place by the deal, coupled with the lingering uncertainty surrounding the debt ceiling, leads us to expect a weak economic start to 2013," Russ Koesterich, Managing Director, BlackRock's Global Chief Investment Strategist, said in a research note.
With the debt ceiling just right around the corner, investors will probably see more market swings.
"We expect to see more volatility," Koesterich said. "Investors should be prepared for a bumpier ride in 2013, at least until Washington produces a more definitive, long-term agreement."
For instance, the CBOE Volatility Index, or "VIX," topped out around 23 before the fiscal cliff deadline, but it has since dipped to levels last seen in 2007.
- iPath S&P 500 VIX Short Term Futures ETN (NYSEARCA:VXX)
- VelocityShares Daily 2x VIX Short-Term ETN (NASDAQ:TVIX)
"We expect consumption levels to be weak," Koesterich added.
Along with the slow income growth and high debt levels, consumers will now face the expiring payroll tax holiday, upper-income households will see higher taxes, and the late deal will translate to delayed tax filings and tax refunds.
"We suggest investors remain cautious on U.S. small caps and consumer stocks, which typically fare relatively poorly in slow-growth environments," Koesterich said.
- iShares Russell 2000 Index Fund (NYSEARCA:IWM)
- Vanguard Small-Cap ETF (NYSEARCA:VB)
- Consumer Discretionary Select Sector SPDR Fund (NYSEARCA:XLY)
- SPDR S&P Retail ETF (NYSEARCA:XRT)
On the other hand, Koesterich suggests looking at U.S. large- and mega-cap companies that have a large global footprint and less sensitivity to domestic growth.
"U.S. companies are highly profitable and reasonably priced, but they are somewhat expensive relative to other markets currently," the analyst said. "Instead, we believe investors should consider overweighting emerging markets, smaller developed countries and peripheral European exporters."
- Vanguard FTSE Emerging Markets ETF (NYSEARCA:VWO)
- iShares MSCI Emerging Markets Index Fund (NYSEARCA:EEM)
- iShares MSCI Israel Capped Index Fund (NYSEARCA:EIS)
- iShares MSCI Switzerland Index Fund (NYSEARCA:EWL)
Lastly, the iShares analyst also thinks that dividend stocks still look attractive. The new fiscal debt deal will mean higher rates for some taxpayers, but it "should not have a significant effect on dividends," Koesterich said. Moreover, Koesterich points out that companies have room to raise dividends to compensate for the tax changes.
- Vanguard Dividend Appreciation ETF (NYSEARCA:VIG)
- iShares Dow Jones Select Dividend Index Fund (NYSEARCA:DVY)
Max Chen contributed to this article.
Full disclosure: Tom Lydon's clients own DVY, IWM and EEM.
Disclosure: I am long DVY, IWM, 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.