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Right now the U.S. is in a deep recession. None of us know for sure when it will end, and the short-term indicators are inconclusive. Yet there is one thing I’ve learned from years of investing: The stock market is not just a big monolith. It’s a complex machine with lots of moving parts — and they don’t all move together.
Of course, figuring out which part of the market will move in which direction at any given time isn’t so easy. However, three market sectors tend to do better in a weak economy. You’ll sometimes hear them called the “defensive” sectors.
Today I’ll tell you what they are and name some ways you can play them with ETFs. As you’ll see, I like “global” sector funds that divide up the world based on economic sectors instead of countries or regions. I think this global approach usually gives you the best exposure to any given sector.
Defensive Sector #1:
Consumer Staples
A consumer staple is something that people buy because they don’t have much choice. Examples include:
- Toilet paper
- Bread and milk
- Diapers
- Coffee
- Cigarettes
Everyone has to eat, but they don’t have to eat in fancy restaurants. And it’s a lot cheaper to stock up on groceries and do your own cooking at home.
Likewise, when I say “coffee,” I mean the kind that you buy at the grocery store in a can — not the gourmet-brewed coffee from places like Starbucks.
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| Wal-Mart is the place to shop in a recession. |
My favorite ETF in this sector is the iShares S&P Global Consumer Staples (KXI), which owns companies like Proctor & Gamble, Nestle, and Wal-Mart — solid basic-goods stocks. I also like the fact that KXI has more than 45 percent of its assets in non-U.S. companies.
If you want to stick to large-cap domestic stocks, the Consumer Staples Select Sector SPDR (XLP) is a very popular choice. And for an interesting sub-sector fund, be sure to check out the Market Vectors Agribusiness (MOO), which buys stocks devoted to food production and distribution.
Defensive Sector #2:
Utilities
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| Electric utilities have a captive market. |
The utilities sector is defensive because its customers have limited control over how much they spend. Yes, you can adjust the thermostat and turn off a few lights, but your electric bill is still likely to be a lot of money. You can’t eliminate it completely unless you live in a primitive campground.
Meanwhile, the companies that provide electricity, water, and gas have a legal monopoly in most places. Even better (for them) … when their costs go up they’re often allowed to pass the bill on to you through “fuel surcharges” and the like.
Utilities stocks are often thought of as “income-producing” securities, and in many cases they do pay nice dividends. But they can grow very nicely, too.
A good way to zero in on this sector is with the iShares S&P Global Utilities (JXI), which has 38 percent of its assets in U.S. companies, 12 percent in Germany, 10 percent in France, and 9 percent in Japan. JXI is currently yielding a very nice 6 percent.
And if you want a U.S.-focused utility ETF, you could invest in the Utilities Select Sector SPDR (XLU).
Defensive Sector #3:
Health Care
It’s hard to put a price tag on your health. You may have to make some tough choices, but people will cut back on a lot of other things before they stop spending on their family’s medical needs.
The result: Hospitals, drug companies, and related businesses have a layer of insulation that protects them from the impact of a stagnant economy. Leaders like Johnson & Johnson, Novartis, and Pfizer are good examples.
The iShares S&P Global Health Care (IXJ) is my favorite way to get exposure to the worldwide health care sector. IXJ has about 63 percent of its portfolio in the U.S., 13 percent in Switzerland, and 10 percent in the United Kingdom.
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| Everyone needs medicine when they’re sick. |
If you’d like to be more aggressive, the iShares Nasdaq Biotechnology (IBB) is a very liquid way to trade the cutting-edge biotech subsector. This is where a lot of the health care growth has been concentrated in recent years.
Of course, the fact that these sectors tended to do well in past recessions is no guarantee they’ll do likewise in the future. They can and will have losing periods, even in favorable economic conditions.
It’s also important to remember that sometimes “outperformance” just means “losing less than everything else.” For instance, if the broad market drops 20 percent and health care only falls 5 percent, you did 15 percent better than average — but you still lost money.
Finally, the defensive characteristics of these sectors are a two-edged sword. Just as they tend to be the strongest sectors during a recession, they also tend to be among the weakest sectors during an economic expansion.
Remember, whatever the economy does, you’ll never run out of ways to profit with ETFs.
Best wishes,
Ron
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