ETFs for Sequestration Speculation

Joel Anderson |

XAR, ITA, PPA, FLM, CORN, DBA, spending cuts, sequestration, speculation, automatic cuts, super committee, congress, defense spending, pentagon, defense budget, discretionary spendingThe apparent failure of the Congressional Joint Select Committee on Deficit Reduction, better known as the Super Committee, means that $1.2 trillion in spending cuts over the next decade will automatically be triggered. These cuts, evenly distributed between defense and discretionary spending, were intended to scare Democrats and Republicans into forming a consensus. Unfortunately, this proved not to be the case, and, short of congressional action, those automatic cuts, also known as sequestration, will go into effect in January of 2013.

Once investors manage to shake off the utter shock over congress failing to find a compromise, they might begin to consider which sectors could be most affected by sequestration and how they might be able to speculate on them. As is often the case, investors interested in making bets about shifts that ripple across an entire sector can be best served by ETFs, which will allow them to make bets on broader market movements that might be triggered by the spending cuts.

Trading Defense Spending Cuts

With $600 billion in spending cuts coming from the Pentagon over the next decade, the Defense Department is looking at having to cut nearly 10 percent of the annual $550 billion budget. Defense Secretary Leon Panetta has already laid out an outline for what those painful cuts might look like, and it appears that the American military is on the verge of major changes. There are three ETFs linked to the defense industry, which will undoubtedly be affected by such cuts. The PowerShares Aerospace & Defense Portfolio (PPA) has the heaviest average volume. It seeks to match the SPADE Defense Index. There's also the iShares Dow Jones U.S. Aerospace & Defense Index Fund (ITA), which is linked to the Dow Jones Aerospace and Defense Index. Finally, the SPDR S&P Aerospace & Defense ETF (XAR), linked to the S&P defense index, is an option.

Non-Defense Discretionary Cuts

The other half of the sequestrations will come from discretionary spending, and it's still hard to say precisely what will be cut. The discretionary budget funds the cabinet departments and agencies, meaning that a wide variety of different programs could be facing cuts. Everything from agricultural subsidies to highway construction could find their way onto the chopping block, making it difficult to determine exactly what direction the cuts will take. However, anyone wishing to speculate on where the ax will fall hardest could use one of several different ETFs to help them speculate on how the markets will fare.

One of the most obvious answers could be the First Trust ISE Global Engineering and Construction Index Fund (FLM), an ETF linked to the ISE Global Engineering and Construction Index, which specifically targets companies that are engaged in large civil and capital projects such as infrastructure.  Reduced discretionary spending would most likely mean a reduction in infrastructure spending.

Another industry that could be affected by the automatic cuts in discretionary funding is agriculture. Farm subsidies have been under fire of late, and that could make them a target for spending cuts. Investors looking to speculate on the future of American agriculture subsidies might find the tool to do so in ETFs linked to agricultural commodities futures, like the PowerShares DB Agriculture Fund (DBA), which is linked to the DBIQ Diversified Agriculture Index Excess Return, or the  Teucrium Corn Fund (CORN), which moves based on corn futures. Corn is by far the largest subsidized crop by the U.S. government.

Finally, the Department of Energy's budget falls under discretionary spending, so government loans and financial support to the budding clean energy industry could be targeted. An investor looking to bet on whether or not this is the case might utilize the PowerShares WilderHill Clean Energy Portfolio (PBW), the Market Vectors Global Alternative Energy ETF (GEX), or even the iShares S&P Global Clean Energy Index Fund (ICLN).

The Government of a Thousand Cuts

While congressional efforts are already underway to reverse the automatic cuts, it doesn't appear at the moment that either party has the political clout to push through legislation that would stop them. For an investor looking to take advantage of this, ETFs might be the best avenue for speculating on the broader shifts in the economy caused by sequestration.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
CHA China Telecom Corp Ltd ADS 47.94 0.16 0.33 5,439
ICLN iShares S&P Global Clean Energy Index Fund 8.09 0.07 0.87 47,431

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