President Obama delivered a speech at George Washington University earlier this week outlining plans to address the government’s significant debt burden. While the speech contained a lot of political rhetoric, there were several specific things mentioned that could impact public companies. As a result, these are the two potential ways to profit from potential upcoming spending cuts.
Time to be Defensive on Defense Stocks
With plans to cut some $400 billion on security spending over a 10-year period, President Obama’s proposed budget cuts could dramatically curtail funding for many defense contractors. Military spending worldwide also grew more slowly in 2010 than 2009, according to a recent report by the Stockholm International Peace Research Institute.
Many analysts like Goldman Sachs echoed these concerns, saying that defense cuts similar to deeper than the revisions in 2011 are likely for 2012, and reiterated its Sell ratings on L-3 Communications (NYSE:LLL), Lockheed Martin (NYSE:LMT) and Northrop Grumman (NYSE:NOC). However, defense stocks, as measured by ETFs like iShares Dow Jones U.S. Aerospace & Defense (NYSEARCA:ITA) are still trading up year-to-date.
As a result, investors may want to consider short selling, buying puts or selling calls against baskets of defense stocks or related ETFs. Those looking to hedge out the risk of a broad market rally can also consider purchasing a U.S. equity index or related call options to create a pairs trade. Given the uncertain environment in the U.S. and a global slowdown, this trade has a good risk/reward ratio.
Generic Pharmas are Really Quite Special
As part of an agenda to control healthcare costs, President Obama’s plan called for numerous initiatives designed to promote generic pharmaceuticals. This may be bad for big pharmaceutical companies, but generic manufacturers like Teva Pharmaceuticals (NYSE:TEVA) and Hi-Tech Pharmaceutical Co. (NASDAQ:HITK) could benefit handsomely from any moves to make their life easier.
Specifically, President Obama proposed cutting the number of years that a drugmaker could exclusively market brand-name biologic drugs to seven years from 12 years. Meanwhile, he also proposed setting limits on so-called “pay-for-delay” deals that set back lower cost rival drugs with settled patent challenges and agreements between big pharma and generic manufacturers.
Investors looking to capitalize on this trend may want to consider purchasing long-term stock positions in generic drug manufacturers, or perhaps using LEAPS to purchase a basket of securities for an affordable price. And again, those looking to offset any broad market declines could purchase an index LEAPS put or short-sell an index to create a pairs trade.
While President Obama’s spending cuts aren’t likely to happen overnight, the general consensus surrounding the level of debt in the U.S. points to austerity measures being implemented. Based on his speech earlier this week, these are two ways to profit from the possible implementation of these reforms.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.