This article is a part of InvestorPlace.com’s Best ETFs for 2020 contest. Kent Thune’s choice for the contest is the Consumer Staples Select Sector SPDR Fund (NYSEARCA:XLP).
When I selected the Consumer Staples Select Sector SPDR Fund (NYSEARCA:XLP) for the best ETFs 2020 contest, there was no indication the market would see a Black Swan event, followed by a historic bear market, both before the end of the first quarter. But for many of the same reasons it was attractive in December 2019, XLP is still a smart holding for the remainder of the year.
While the 2020 calendar year began on Jan. 1, the investment year, as defined by the novel coronavirus bear market, began Feb. 19, when stocks hit their last high mark.
In that first six-week period, momentum from 2019 was carrying forward as the riskier sectors, such as technology, were leading the boring, defensive sectors, such as consumer staples. In the height of selling during mid-March, consumer staples was a leading sector and XLP was in the No. 1 position on the InvestorPlace best ETFs for 2020 list by as much as 600 basis points.
Although it’s not the leader right now, there’s still something very important to take away from all of this. Consumer staples is a defense play. When stock prices are falling, XLP will typically fall less than the broader market indices, and much less than riskier areas of the market.
Why XLP Is Still Among the Best ETFs for 2020
There are several potential benefits of holding a consumer staples fund like XLP during the COVID-19 bear market and recession. Here are a few of the greatest perks:
• Downside protection: When stock prices are falling, the prices for consumer staples stocks are generally falling less. But although upside potential is not typically as high as the more beaten down stocks or sectors, XLP shareholders can still participate in gains when the market bounces back up. In summary, XLP is less volatile than the broad market indices, such as the S&P 500.
• Social distancing impact: Stay-at-home stocks like Amazon (NASDAQ:AMZN) and Zoom Video Communications (NASDAQ:ZM), can benefit from the social distancing and quarantining imposed thanks the new virus. But when U.S. consumers need to leave their homes, they are buying their everyday consumer products, which can benefit XLP’s top holdings. Such stocks include, Walmart (NYSE:WMT), Costco (NASDAQ:COST), and Procter & Gamble (NYSE:PG).
• Risk of longer-than-expected recession: It’s arguably not a smart bet that the U.S. economy will experience a short-term, v-shaped recovery. Investors have no precedent to draw upon. Federal stimulus is a short-term fix, not a sustainable solution. When the reality of a longer-than-expected recession replaces the v-shape fantasy, solid defensive ETFs like XLP will look more attractive.
• Loss of appetite for buy-the-dip stocks: If you’re watching the market closely, or if you hold a diverse range of stocks, you’ve noticed that the biggest gainers on the bear market upswings are the riskier stocks, such as tech stocks and small-cap stocks. If the market continues its volatility, especially if we see a sucker’s rally, where too many buyers jump back into the market too soon, buying on the dip will be less common and buying quality stocks for the long-term may resume.
The Bottom Line on XLP
You may have noticed that most of this article consists of opinion, or logical projection, as it were, about the market and economy in 2020. When information and data are short or absent, an investor must use their intuition, which comes from a combination of experience and educated guesses. In the short term, no one knows where the market is headed. But it’s a reasonable bet that the U.S. is already in a recession, which will last months, not weeks. In this environment, a consumer staples fund like XLP can be a smart core holding or a satellite holding to add diversity to a portfolio.
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.