As one of the largest forms of consumer borrowing recently, student debt has surged significantly in the last decade. According to Council on Foreign Relations, $1.6 trillion which is collectively owed by around 44 million U.S. borrowers raise questions about the current federal lending policies.

Over the last two decades, student debt has experienced a twofold increase in quantity. When factoring in additional private loans, this total is more than $1.7 trillion, surpassing both auto loans and credit card debt. The staggering $1.7 trillion debt is only eclipsed by home mortgage debt, which comes in at $12 trillion.

According to Education Initiative Data, the economic effect of increasing student debt has a similar effect as a recession, restricting business growth and reducing consumer expenditure. Between 2019 and 2023, average student loan debt increased by 3.6%, while the U.S. economy contracted by 3.4%.

Any Support to Reduce the Burden?

Students falling behind in their payments becomes the biggest issue when dealing with huge debt amounts. With just 7% of the 44 million borrowers carrying more than one-third of the total debt, the risk of defaults increases, posing a serious concern.

According to Investopedia, in 2022, the Biden-Harris administration proposed $20,000 student debt forgiveness, but it was invalidated by the Supreme Court, raising questions about future debt relief efforts.

The White House initiated a one-year 'on-ramp' period from Oct 1, 2023, to Sep 30, 2024, to ease the burden. During this time, borrowers will make payments and accrue interest without it being capitalized and late payments without resulting in default.

Is Debt Cancellation the Solution?

Forgiving student debt would provide considerable stimulus to the U.S. economy, as forecast by Moody's Investor Service and quoted on Investopedia, with potential benefits like increased homeownership and small business growth. However, the idea of a broad cancellation of the debt amount raises concerns that it would be unfair to those who have successfully paid off their debt or avoided it in the first place.

According to Investopedia, a study conducted in 2018 by the Levy Economics Institute at Bard College estimated that complete debt cancellation could increase the GDP by an annual range of $86 billion to $108 billion.

ETFs in Focus

The impact of rising student debt isn't limited to reduced spending power, it also casts a shadow over real estate purchases and entrepreneurship levels in the country, among other things. This comes on top of the possibility that the Fed will remain hawkish for a longer duration and looming fears of a government shutdown.

Below, we highlight a few ETFs areas that could be affected and where the investors could invest to navigate the uncertain environment in a better way.

ETFs to Lose

Consumer Discretionary ETFs

Loan repayments are estimated to result in a $100 billion deficit in the pockets of borrowers, according to Wall Street Journal, as quoted on Barchart, indicating that discretionary spending by the debt-burdened consumers is poised to take a beating.

With credit card debt already surpassing the $1 trillion mark, persistently high inflation and a hawkish Fed have already resulted in increased default rates. The resumption of student debt repayments is a key negative for consumer discretionary ETFs.

Investors can be on the look out for funds like Consumer Discretionary Select Sector SPDR Fund (XLY Quick QuoteXLY - Free Report) , Vanguard Consumer Discretionary ETF (VCR Quick QuoteVCR - Free Report) and First Trust Consumer Discretionary AlphaDEX Fund (FXD Quick QuoteFXD - Free Report) . These funds have lost 7.19%, 8.01% and 9.70%, respectively, over the past month.

XLY, VCR and FDIS have Amazon (AMZN Quick QuoteAMZN - Free Report) as their top holding with 22.13%, 22.21% and 21.77%, respectively. According to Numerator, as quoted on Business Insider, debt-burdened consumers allocate about 18.58% of  their discretionary spending to Amazon alone, increasing volatility for the company.

Housing ETFs

Increasing student debt poses threat to the U.S. housing market, pushing up chances of restricting investments in the market. Education Initiative Data indicates that about 36% of students with outstanding debt are less inclined to invest in real estate.

Already struggling with high mortgage rates and low inventory levels, the negative effect of loan repayments results in further headwinds for the market. Investors can keep an eye on ETFs like - iShares U.S. Home Construction ETF (ITB Quick QuoteITB - Free Report) , SPDR S&P Homebuilders ETF (XHB Quick QuoteXHB - Free Report) and Hoya Capital Housing ETF HOMZ. These funds have lost 13.73%, 12.35% and 12% over the past month, respectively (Read: How Rising Rates Are Impacting Housing ETFs).

ETFs that can Gain

Quality ETFs

Amid market uncertainty, quality investing emerges as a strategic response as a potential buffer against student debt repayments and a looming shutdown. This approach prioritizes identifying firms with robust fundamentals, consistent earnings, and lasting competitive strengths. Investing in such high-quality companies can mitigate volatility for investors (Read:Time for Quality ETFs as Consumer Confidence Wanes?).

Investors can look at funds like American Century U.S. Quality Value ETF (VALQ Quick QuoteVALQ - Free Report) , Invesco S&P SmallCap Quality ETF (XSHQ Quick QuoteXSHQ - Free Report) and SPDR MSCI USA StrategicFactors ETF (QUS Quick QuoteQUS - Free Report) .

Consumer Staples ETFs

Upcoming debt repayments expected to burn a significant hole in consumer’s pockets, indicate that consumers can shift toward more budget-conscious choices as they tend to prioritize essential products. This shift can benefit consumer staple stocks, as these companies manufacture everyday necessities such as food, beverages, and household items.

Funds like Consumer Staples Select Sector SPDR Fund (XLP Quick QuoteXLP - Free Report) , Vanguard Consumer Staples ETF (VDC Quick QuoteVDC - Free Report) and iShares U.S. Consumer Staples ETF (IYK Quick QuoteIYK - Free Report) are expected to benefit.