Any investor can make money during the good times when the market is rolling. But making money, or simply not losing money, during periods of inactivity is what sets the best investors apart. Investors need to think long-term about the entire business cycle when choosing stocks or exchange-traded funds (ETFs), because one bad year can wipe out three or five years of strong returns.
One of the most difficult environments to invest in is during a recession, when economic activity contracts, often sending investors to the sidelines. But this ETF can help you weather the storm, based on 30 years of market data.
Investors with a long-term horizon should be prepared to deal with volatility, especially in some of their high-growth names. However, it will also help your overall portfolio — and probably feel good — to have some exposure to defensive sectors that can outperform in downturns and may even provide you with reliable passive income.
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Consumer staples have historically been the strongest sector during a recession. These are companies that make products that consumers consider essential in their budgets. Remember, consumer spending accounts for nearly 70% of US gross domestic product (GDP). Essential products are things like toothpaste, food and medicine, things that the consumer needs on a daily basis and simply cannot afford to waste.
While consumer goods may not deliver as big returns as sectors like artificial intelligence in a rising market, they tend to prove robust in a downturn, as historical data shows. According to data compiled by Bloomberg and iFAST, consumer goods outperformed all other sectors in the 12 months before and 12 months after the start of recessions dating back to 1990. These include the early 1990s recession, the Dot-Com bubble, the Great Recession and the COVID-19 pandemic.
In the 12 months leading up to these recessions, consumer staples generated an average return of 14%. In the 12 months since the start of the recession, the sector has generated an average return of 10%.
The SPDR fund for the consumer staples sector(NYSEMKT: XLP) launched in 1998. Over 31% of the fund is invested in consumer staples distribution and retail stocks, nearly 20% in beverages, 18.5% in food, over 17% in household products and nearly 10% in tobacco. The fund holds many of the stocks you might expect a consumer ETF to hold. Here are the fund’s top five holdings by weight.
Walmart — 11.05%
Costco Wholesale — 9.33%
Procter & Gamble — 8.18%
Coca cola — 6.62%
Philip Morris International — 5.77%
While returns since inception have been modest, the fund also boasts a strong trailing 12-month dividend yield of 2.71% and a solid track record of over 25 years of dividend payouts and growth.
XLP Dividend Chart
XLP Dividend Data by YCharts
Now, since returns haven’t been that good over the long term, investors don’t have to put all their capital into consumer goods. In fact, if you do, you could lose money if your returns don’t keep up with inflation. Investors should allocate a portion of their capital to an ETF like XLP and can increase their allocation as they approach retirement, focusing on fund preservation rather than growth as they age.
An ETF can also be a good place to park capital if you’re worried about frothy market conditions like those seen today and don’t feel comfortable putting money into S&P 500 index, which is heavily concentrated in the Magnificent Seven and a handful of other high-flying AI stocks. Finally, when considering portfolio construction, long-term investors can allocate a substantial portion of their capital to growth sectors while placing some capital in defensive sectors for a balanced approach.
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Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Costco Wholesale and Walmart. The Motley Fool recommends Philip Morris International. The Motley Fool has a disclosure policy.
The Safest Dividend ETF for a Recession — Based on 30 Years of Market Data was originally published by The Motley Fool
