For a Post-Election Risk On Rally, Buy These ETFs

Tuesday is Election Day. Political passions and tensions are running high in the U.S. and market participants are still trying to figure out what outcome is best for stocks. Conventional wisdom has been that an upset of President Obama by Republican challenger Mitt Romney coupled with the GOP regaining control of the Senate could spark a risk on rally.

That does not mean a risk on rally cannot happen if the President is reelected. Along those lines, some market observers note stocks really do not care who resides at 1600 Pennsylvania Ave. With the fiscal cliff looming, it may not matter who wins this election unless he (and Congress) can come together to avert that treacherous scenario.

In a perfect world for the bulls, stocks will rally following this election, regardless of outcome and the fiscal cliff will be averted. Should all that happen, these are some of the ETFs investors will want to be involved with.

iShares Dow Jones U.S. Aerospace & Defense Index Fund (NYSE:ITA) Or the PowerShares Aerospace & Defense Portfolio (NYSE:PPA). Or the SPDR S&P Aerospace & Defense ETF (NYSE:XAR). These ETFs are the quintessential "avoids" under a fiscal cliff scenario on the expectation that defense spending will be slashed.

Conversely, these funds are viewed as buys assuming Romney wins and the Republicans gain control of the Senate. That might just be what these ETFs are starting to price in. As Barron's notes, PPA touched its highest levels since June 2008 today. For its part, ITA is up nearly two percent and trading less than $1 away from its 52-week high.

Vanguard Dividend Appreciation ETF (NYSE:VIG) Or any of VIG's competitors such as the SPDR S&P Dividend ETF (NYSE:SDY) and the iShares High Dividend Equity Fund (NYSE:HDV). Dividend stocks and ETFs are often viewed as being less volatile than non-dividend payers and that is true, but the fiscal cliff would mean the loss of Bush-era dividend tax cuts.

Expired tax reductions equal tax increases. The resulting fear is that fewer companies will be inclined to pay or raise dividends if the dividend tax rate jumps due to the fiscal cliff. How dividend ETFs trade immediately following the election could be a tell regarding the market's view on the odds of the fiscal cliff taking place. If Mr. Market likes the result of today's election, expect dividend ETFs to participate in, and perhaps lead, a risk on rally.

WisdomTree Dreyfus Emerging Currency Fund (NYSE:CEW) Currency ETFs such as the PowerShares DB Dollar Bullish (NYSE:UUP) and the PowerShares DB Dollar Bearish (NYSE:UDN) could easily put in some exaggerated moves immediately following the election. However, the impact of U.S. politics on emerging markets currency is could be muted. Bank of America-Merrill Lynch said as much, saying the impact on developing markets currencies will be "neutral."

That is good news for CEW, which is an ETF that would likely benefit from risk on rally. CEW has almost $280 million in assets under management. Consistent currencies include the following: Mexican Peso, Brazilian Real, Chilean Peso, Colombian Peso, South African Rand, Polish Zloty, Russian Ruble, Turkish New Lira, Chinese Yuan, South Korean Won, Indonesian Rupiah, Indian Rupee, Malaysian Ringgit, Philippine Peso and Thai Baht.

PowerShares Emerging Markets Sovereign Debt Portfolio (NYSE:PCY) There are several reasons why an emerging markets sovereign debt ETF such as the PowerShares Emerging Markets Sovereign Debt Portfolio will make for a useful election play. First, PCY and its rivals are income funds. PCY pays a monthly dividend, so it could be a winner in a "missed fiscal cliff" scenario.

Second, a legitimate risk on rally would ignite emerging markets ETFs. The good news is PCY is already in rally mode, having gained almost 19 percent year-to-date including dividends paid. Third, as a bond ETF, PCY is not overly volatile. The ETF's year-to-date volatility is just 4.9 percent.

Finally, PCY is not intimately correlated to the S&P 500. PCY has a three-year correlation to the SPDR S&P 500 (NYSE:SPY) of 0.69, according to State Street data. Said another way, dollar-denominated emerging markets bonds, of which PCY is comprised, have been less correlated to the benchmark index than the Consumer Staples Select Sector SPDR (NYSE:XLP) and the Health Care Select Sector SPDR (NYSE:XLV) have been.

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