ETFs spin off US election

PORTFOLIO POINT: US index funds tracking bonds, financial and insurance stocks, healthcare and shale gas all have an indirect stake in the US election outcome. And investors are cashing in, regardless of who wins the Presidential race.

Barack Obama’s initial message of hope may have been drowned out by shouting over unemployment and government debt, but there are plenty of reasons for investors to remain optimistic heading into the next US presidential election.

In fact, Obama’s first three-and-a-half years in office have been lucrative for those who waded into the US stockmarket.

The S&P 500 is up more than 75% since the President was sworn in on January 20, 2009, in what has been the strongest first-term rally since Dwight Eisenhower was elected in 1953, according to Reuters (it’s less in Australian dollar terms, but still a big rise). What’s more, a likely third round of quantitative easing by the Federal Reserve looks set to provide additional support just in time for the November 6 poll.

While a lighter Fed toolbox, anaemic growth and fiscal cliff negotiations are bound to make life more difficult for whoever occupies the White House come 2013, the political landscape does present opportunities for Australian investors – especially while the Aussie dollar remains elevated. And now that Republican presidential hopeful Mitt Romney has locked in Paul Ryan as his running mate, we’re better able to examine the big policy issues set to shape financial markets.

Romney says one of his main priorities as President would be to reduce the budget deficit and cap government spending at 20% of GDP. While Romney is yet to outline his plan in any kind of detail, adding Ryan to his ticket appears to have confirmed his resolve – the vice-presidential hopeful has campaigned loudly to slash entitlements and overhaul the welfare state.

Decreased government spending generally weighs on equities, but reduced US debt issuance would be expected to extend the current rally in government bonds, providing a new opportunity to go long on the Treasury yield curve. One of the safest ways to do that is with the Vanguard Long-Term Government Bond ETF (VGLT), tracking a selection of US government securities with maturities of greater than 10 years, which offers small-yet-stable yields, and upside potential if Romney comes good on his budget promises.

That’s not to say a Republican White House would be bad for stocks. Romney, a former private equiteer, wants to roll back Obama’s Dodd-Frank Wall Street regulations wherever he can, which would be a positive for financial firms that are already contributing heavily to his campaign.

Bloomberg ETF strategist Eric Balchunas points out many of Romney’s biggest donors, including Goldman Sachs, Morgan Stanley and Charles Schwabb, are tracked by the iShares Dow Jones Broker Dealers ETF (IAI), which is expected to receive a boost under a changed administration.

Another important platform for the Republicans is US energy independence, which plays into the hands of the controversial hydraulic fracturing industry behind a new boom in shale gas. Obama has pushed back against “fracking”, as it’s known, due to the potentially harmful chemicals used in the drilling process. But Balchunas expects a fracking-friendly Romney administration would boost the Market Vectors Unconventional Oil and Gas ETF (FRAK), which is focussed on large-cap US oil and gas plays.

The Republican Party Platform now also calls for the establishment of a “gold commission”, which would consider restoring a link between the precious metal and the US dollar. A return to a gold standard would present a number of practical problems (Christopher Mahoney, a former vice chairman of Moody’s, has written a good critique at Project Syndicate), but, following five years of easy monetary policy at the Fed, there is certainly a growing concern about America's ability to continue printing itself to prosperity. The idea would require heavy bullion buying by the US government, making a solid case for gold investments, including the physically backed, ASX-traded Gold Bullion Securities ETF (GOLD). However, this one's a long shot.

On the Democratic side, a win by Obama would go a long way in reducing the political uncertainty that has plagued the incumbent’s reform agenda. This is particularly true of the President’s Affordable Care Act, or ‘Obamacare’, which aims to extend health insurance coverage uce the overall cost of healthcare in America. Unsurprisingly, the multi-trillion-dollar commitment has drawn fire from small-government Republicans.

Under Obamacare, the biggest winners are the major health insurance companies – especially those that offer low-risk insurance for younger healthcare consumers – which will be flooded with new customers. There has already been a flurry of takeover activity in the sector since June, when the US Supreme Court upheld the Act, and insurance stocks would benefit some more if Romney loses the election and his ability to repeal the laws, as he has vowed. (Nomura recently weighed in on the likely effects on Australian health stocks in The Wall Street Journal.)

Christian Magoon, CEO of Magoon Capital, suggests the simplest way to play the uptrend is to invest in the Dow Jones US Health Care Providers ETF (IHF). “Don’t be fooled by the name,” he says, “many healthcare providers provide risk services whereby they accept patients for a flat rate in exchange for the surplus beyond the cost of providing care.”

Magoon, who specialises in ETF investing, also expects a re-elected Obama government to support pharmaceuticals firms, thanks to the hundreds of millions of new US customers his laws have the potential to unlock. In this space, the Dow Jones US Pharmaceutical ETF (IHE) offers cheap exposure to 38 well-positioned, profitable companies, including Johnson & Johnson, Pfizer and Merck.

This is by no means a definitive list of US election opportunities, which run deeper than broad-sector bets (Bank of America Merrill Lynch last week released its individual stock picks for the Obama and Romney administrations, which are worth a read if index investing isn’t for you).

But it goes to show that no matter whether the US government is blue or red, there are still greenbacks to be made.