The market is beginning to look tired and expensive and seasonality will soon begin to weigh heavily on stock prices. Investors employing tactical portfolio structures are wise to consider adding to defensive funds now — and there’s no more effective ways to do it than with sector ETFs.
Although bull markets do not die of old age, the investor herd still begins to shy away from risk as every new milestone is added to duration of a bull run. This investor sentiment alone is enough to become a self-fulfilling prophecy by triggering a correction.
Or the awareness of an aging bull market can make the herd keep an eye on the exit even as it advances forward with greed. That eye looking toward the exit is the same one that will notice fundamentals such as high relative prices, or economic conditions such as a Fed standing ready to tighten credit, and look increasingly for selling points.
The current price-to-earnings ratio on the S&P 500 is above 20, which is not exactly at nosebleed levels but it is a point at which to begin polishing off the defensive strategies, especially when entering into the late phase of the business cycle as we are arguably doing now.
Amidst that backdrop, here are three of the best defensive funds, which happen to be SPDR ETFs.
3 Best Defensive Funds: Health Care Select Sector SPDR (XLV)
Click to Enlarge Healthcare may be that one sector that has the market leading momentum to stay strong in the short term, but also enough defensive value to stay ahead of the broad market in a downturn.
The Health Care Select Sector SPDR (NYSEARCA:XLV) is a solid choice to accomplish this goal.
The bio-technology subsector of healthcare is a 2015 market leader and possibly getting into dangerously overbought territory. However, it is primarily the small- and mid-cap bio-techs that are the hottest.
But the portfolio for XLV consists of healthcare stocks found in the S&P 500, which consists of large-cap stocks that are generally North American stocks of high quality. Although performance can lag in the short term when the sector gets hot, this makes for a stronger defensive move than a healthcare fund heavy in today’s high-flying biotech stocks.
The expense ratio is low 0.15%, or $15 for every $10,000 invested.
3 Best Defensive Funds: Consumer Staples Select Sector SPDR (XLP)
The idea behind the consumer staples sector (also known as consumer non-cyclical) as a defensive stock play is that when the economy slows down and money gets tight, consumers still leave room in their budget for their favorite foods and vices while continuing to shop at discount retailers.
Therefore the consumer staples sector invests in consumer products and services that people tend to buy in all phases of an economic cycle. There can be some overlap with other defensive sectors, such as healthcare and utilities, but ETFs such as XLP hold plenty of other industry stocks.
Top holdings Proctor & Gamble Co (NYSE:PG), the Coca-Cola Co (NYSE:KO), Wal-Mart Stores, Inc. (NYSE:WMT), Philip Morris International Inc. (NYSE:PM) and CVS Health Corp (NYSE:CVS) combine to make up 41% of the fund.
Topping off this superior defensive sector ETF is the cheap 0.15% expense ratio.
3 Best Defensive Funds: Utilities Select Sector SPDR (XLU)
Click to Enlarge The utilities sector is another diversification tool that can produce positive returns in the late phase of a bull market but also minimize losses during the worst of a bear market. And Utilities Select Sector SPDR (NYSEARCA:XLU) is an outstanding choice to fill this defensive space.
Who’s going to turn off their water, gas and electric during tough times? Consumers will cut back on their lattes before cutting off their power. Top holdings in XLU include Duke Energy Corp (NYSE:DUK), Nextra Energy Inc (NYSE:NEE) and Dominion Resources Inc (NYSE:D).
In addition to the defensive qualities of utilities stocks, investors looking for income will like the yields that come along with them. XLU has a nice yield of 3.4%.
Like all of State Street’s Select Sector ETFs, XLU has a rock-bottom expense ratio of 0.15%.
As of this writing, Kent Thune did not personally hold a position in any of the aforementioned securities. However his firm holds XLV, XLU and XLP in some client accounts. Under no circumstances does this information represent a recommendation to buy or sell securities.