The U.S. government shutdown has wreaked havoc on stocks, but hints of a potential resolution could help propel some areas in the market and exchange traded funds.
On Wednesday, Rep. Paul Ryan R.-Wisc. proposed a short-term solution to the debt limit, which has drawn broad support from conservatives.
Some of the most recent best performing stocks have taken a beating as investors sold off and tried to lock-in profits after the impressive run. Areas like Internet stocks and biotechnology have been hardest hit.
“The debt ceiling is causing the fear over locking in returns,’” Ian Winer, director of equity trading at Wedbush Securities Inc., said in a Bloomberg article. “Guys are looking at their portfolios and saying, ’These are up huge, maybe I sell some to lock in some gains and revisit post debt-ceiling resolution.’”
Looking at asset categories, riskier small-cap stocks have also been pressured, but small-caps could turn around once the risk-off environment dissipates.
If the U.S. government agrees to terms on raising the debt ceiling, the foreign exchange market could offer investors an interesting opportunity, particularly in emerging markets.
Additionally, financial stocks could see the pressure lifted as many banks have significant holdings in U.S. debt.
Next page includes ETF options to track the five areas:
iShares Nasdaq Biotechnology ETF (NYSEArca: IBB)
Investors who still want to enter the space should target bio-tech large- and mid-caps with more stable earnings and product lines. Looking at ETF market capitalization allocations, IBB follows a traditional market-cap weighted indexing methodology, with large positions in large-caps. [Sell-Off in Biotech ETFs Could Be a Temporary Setback]
First Trust DJ Internet Index Fund (NYSEArca: FDN)
Internet stocks enjoyed strong momentum trading, but the temporary uncertainty hit richly valued tech stocks, especial social-networking companies. Nevertheless, these growth stocks still show strong long-term fundamentals, with growing Internet usage, especially in the emerging markets.
iShares Russell 2000 ETF (NYSEArca: IWM)
Small-caps typically rally in an economic recovery, but they are the first to take the hit in a market turn. Since 1927, a small-cap portfolio has outperformed large-caps by an average of almost 3%, according to Market Oracle. Once markets get off their feet, smaller companies will have room to run again.
WisdomTree Emerging Markets Local Debt Fund (NYSEArca: ELD)
Jens Nordvig, global head of currency strategy at Nomura Securities, points out that higher-yielding emerging-market currencies have room to rally if the U.S. finds a solution to the debt ceiling, reports Erin McCarthy for the Wall Street Journal. Traders will switch away from safe-haven currencies, like the yen, in favor of riskier, and potentially more profitable, emerging market assets.
“We just need to have small positive news to generate a significant rally,” Nordvig said in the article.
Financial Select Sector SPDR (NYSEArca: XLF)
Big banks own a lot of U.S. debt, so a default would not be good for business. On the flip side, banks should also sigh with relief after a resolution is passed.
“It is my strong belief that a true default by the United States Treasury would wipe out bank equity,” Dick Bove, at Rafferty Capital Markets, said in a NBC News article. “All bank lending to the private sector in the United States would stop, immediately. Existing loans would not be rolled over. Immediate repayment would be demanded.”
Full disclosure: Tom Lydon’s clients own IWM.