Although the odds of a recession occurring in the New Year are low, investors are wise to bet that some of the best exchange-traded funds for 2020 will be the funds that can perform well in a slowing economy.
When beginning the search for the best ETFs to buy in 2020, a smart place to begin is with a review of where the economy stands in relation to the business cycle. At the close of 2019, the U.S. economy was clearly showing classic, late-phase business cycle signs.
In the late-phase economy, the recovery is maturing, inflationary pressures are building and Federal Reserve policy is becoming more restrictive. These are just a few of the signs already present or beginning to emerge now.
Here are more recent signs of a late-phase environment or slowing economy:
- November’s reading of the Conference Board Leading Economic Indicator Index (LEI) indicated a decline “for a third consecutive month.”
- The ISM Manufacturing Purchasing Managers Index (PMI) edged down to 48.1 in November, the fourth consecutive month of declining manufacturing activity (a reading below 50 indicates contraction).
- The Consumer Confidence Index remains relatively healthy, but the reading fell for a fourth straight month in November. Consumer spending makes up nearly 70% of the U.S. economy.
- The November U.S. jobs report, released in December, was positive as the unemployment rate fell to a 50-year low at 3.5%. However, most of the jobs added were low wage.
In summary, the U.S. economy is moderately healthy but the expansion is clearly showing signs of a slowdown. With no further monetary or fiscal stimulus in sight, economic conditions will certainly not improve from where they are now. Absent any surprises, the economic environment will remain favorable for stocks in 2020 but investors’ collective appetite for risk may begin to decline as signs of economic sluggishness continue.
How to Invest in 2020
When thinking about how to invest in 2020, a smart way to frame the ETF selection process is to think about how to invest in a moderately healthy economy that is beginning to show signs of weakness but no strong signal of recession. In this environment, investors are wise to focus on dividend-paying stocks. But keep in mind that not all dividend stocks are created equal.
Investors in 2020 are also wise to focus on quality and gravitate toward companies with a long track record of paying dividends in the average to above-average range. Such investments would yield around 3%. Equal and opposite, take caution in buying stocks of companies that pay the highest dividends. Yes, a 10% yield sounds more attractive than 3%, but you don’t want to sacrifice return for yield, especially in a moderating economy, where investors are likely to be rewarded more for quality and price appreciation.
The Case for Consumer Staples Select Sector Fund (XLP) in 2020
The case for the Consumer Staples Select Sector Fund (NYSEARCA:XLP) in 2020 can be summarized simply: Consumers will continue spending this year, but they will begin to be more selective in which goods and services they purchase. Specifically, consumers will spend less on discretionary goods and services, such as luxury items, entertainment and technology, but continue buying the non-discretionary necessity items, such as food, beverages, drugs and basic household products.
In a slowing economy, the smart money will begin to move into high-quality, dividend-paying, large-cap stocks, such as XLP top holdings Proctor & Gamble Company (NYSE:PG), Coca-Cola Co (NYSE:KO) and Altria Group (NYSE:MO). For that reason, I’m picking the XLP to be the best ETF of 2020.
As of this writing, Kent Thune did not personally hold a position in any of the aforementioned securities. However, he holds XLP in some client accounts. Under no circumstances does this information represent a recommendation to buy or sell securities.