Three "Fiscal Cliff" Stocks To Watch

Gaurav is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

All the confusion and uncertainty that surrounds the United States's so-called "fiscal cliff" dilemma makes it difficult for investors to get a clear picture of what's happening. So let's take a step back to see what the actual problem is, what the complicating political factors are and which stocks are heavily exposed to the downsides of a sequestration nightmare.

The Problem
We all remember the 2011 summer standoff over the US raising its debt ceiling, right? Many deficit-hawks demanded huge spending cuts in exchange for allowing the US Treasury to remain solvent and continue its borrowing. However, a political impasse was reached and a super-committee was installed to design a deficit reduction plan. To ensure the success of a committee, Congress passed the Budget Control Act which would allow automatic spending cuts and tax increases to take effect if the super-committee failed to compromise. Of course, the super-committee failed and we are now faced with across the board spending cuts in everything from discretionary spending to military spending. All this coupled with the expiration of a plethora of tax cuts presents a huge threat to the fragile recovery of the US economy. 

The Political Complications
A central tenet of President Obama's reelection campaign was to raise taxes on the wealthy and he has interpreted his substantial victory in November as a mandate to do just that. Republicans, having been significantly weakened after the election, are considering it, but want massive entitlement reform in return. This standoff can get ugly very fast and prevent any lasting solutions from being enacted. Keep a watch out for policymakers to simply extend middle class tax breaks (Bush tax cuts, AMT, Payroll tax cut) and then allow the country to fall off the cliff.

Stocks to Watch
If any investor has Oshkosh Corp (NYSE: OSK) in their portfolio, I would advise them to keep a close eye on the fine print in any fiscal cliff solution. Under current law, funding for their FHTV and FMTV contracts are set to decline next year and the drawdown of US troops in Afghanistan in 2014 will further reduce demand for their specialty vehicles. Furthermore, the spending cuts in the BCA would have a contractionary effect and according to OSK's annual report "any further decline [in the economy] could have a material adverse effect on our operating performance." All in all, with 91% of their defense segment sales going to DoD and with those contracts being under threat of termination, suspension or change, OSK is not a good equity to hold right now.

L-3 Communications Holdings (NYSE: LLL) has had a decent comeback this year with a 14.35% YTD gain but all that may be in jeopardy via the fiscal cliff. When spending cuts are broad an non-surgical in nature and forced on an organization, it causes a reorganization of budget priorities. DoD contracts make up 75% of LLL's business so even a slight change in their contracts could send them into a nosedive. 

The most obvious victim of Congress's ineptitude is obviously Lockheed Martin (NYSE: LMT) and their deep-rooted ties to DoD. Just this year alone, their contracts with the US government nearly topped $19 billion, which is roughly 82% of their total sales. Yes, I know that they have locked in revenue from the F-35s, but they would need to get competitive again if they were working with a tighter-fisted DoD

Are you sensing a common theme here? It's pretty simple, actually. We know there is a fair chance that the far right of the Republican party will force a stalemate on everything except middle class tax cuts, that is until they can use the debt ceiling debate as leverage over the White House. Politics is a short-sighted game but the folks over at the Pentagon have to keep an eye on the long haul. As such, DoD will adjust accordingly to cutbacks set forth by the BCA, which means you should adjust your portfolio to steer clear of defense contractors with too much dependence on US military spending. 

slightlywonkish has no positions in the stocks mentioned above. The Motley Fool owns shares of L-3 Communications Holdings and Lockheed Martin. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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