Fiscal Cliff Fears Are Hammering These ETFs

Since the day after Election Day, fiscal cliff fears have intensified and stocks have tumbled as a result. The SPDR S&P 500 (NYSE:SPY) is off nearly five percent as rampant speculation that Bush-era tax cuts will expire has permeated financial markets.

Expired tax cuts are viewed as de facto tax hikes and the result, some fear, could be another U.S. recession. One of the tax reductions set to expire is the 15 percent tax rate on dividends. Conventional wisdom says that when tax rates on dividends rise, companies are less inclined to pay and increase shareholder payouts. Not surprisingly, investors see dire consequences for dividend ETFs and those funds that track sectors known as "dividend sectors."

ETF issuer WisdomTree pointed out on November 7 the dividend tax went up in 1993, but the highest-yielding stocks performed quite well from the end of 1992 through the end of 2002. Or that market environment is more important than tax environment.

That could ultimately prove to be the case, but for now, just the fear of the fiscal cliff is pressuring the following ETFs.

Utilities Select Sector SPDR (NYSE:XLU) A conservative ETF such as XLU should be the ideal hiding place during times like these. After all, XLU has one of the lowest correlations to the S&P 500 of the nine select sector SPDRs funds. However, XLU has recently failed conservative investors. Normally a slow mover, XLU has plunged 4.7 percent since November.

In the past week, some noted analysts have highlighted issues with the utilities sector. Last week, WisdomTree Research Director Jeremy Schwartz noted U.S. utilities are richly valued relative to their foreign counterparts.

This week, iShares Global Chief Investment Strategist Russ Koesterich said utilities have "been growing progressively more expensive relative to other segments of the market" since the Bush tax cuts and that the sector "may be uniquely vulnerable" if those tax cuts expire. XLU has turned negative on the year and is just 5.8 percent above its 52-week low. iShares Dow Jones US Telecom Index Fund (NYSE: ) Telecom stocks have fared even worse than utilities since the election. Just look at the performance of the iShares Dow Jones US Telecom Index Fund since November. The ETF has tumbled nearly six percent since that day. Like utilities, telecom issues are prized for their low correlations to the broader market and low-beta ways. IYZ does make on the group's low-beta reputation with a beta of just 0.83 against the S&P 500. However, some U.S.-focused telecom ETFs share another trait in common with XLU: Lofty valuations. IYZ's price-to-earnings ratio is 38 and its price-to-book ratio is 3.52, according to iShares data.

Today, IYZ is not only trading at its lowest levels since August, but the fund is in danger of violating its 200-day moving average. If that happens, a return to the June lows is possible.

Vanguard Dividend Appreciation ETF (NYSE:VIG) Including the largest dividend ETF by assets on this list may come as a surprise to some investors. Utilities and telecom names combine for just two percent of VIG's weight. Financials, another sector vulnerable to the fiscal cliff, represent just 6.3 percent of VIG's weight. Consumer staples control about a quarter of VIG's total sector exposure.

All that would be enough to make some investors ask why has VIG been slammed to the tune of 4.7 percent since November 7. Simply put, VIG has proven vulnerable to fears of the fiscal cliff. With investors speculating that companies will pay out less cash in the form of dividends or even reduce payouts if the dividend tax rate rises, VIG has not been immune to selling pressure.

Clearly this is a "sell the fear" event because as Schwartz and Koesterich noted in their respective research pieces, when dividend tax rates have risen in the past, high-yielders have performed well and some companies have actually increased dividends to help mitigate the affect of the higher tax rate.

Given its scant financial services and utilities exposure and a meager 0.13 expense ratio, VIG is more of a buy under the fiscal cliff than the other funds highlighted here.

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