The Fed has been aggressive in bringing down inflation, which is near its highest level since the early 1980s. The action could push the economy into a recession. In fact, short-term yields are risng faster than the longer term. The two-year yields topped 4.1% to a fresh 15-year high, while the 10-year yields hit 3.57%, the highest since March 2011.
This has compelled investors’ flight to defensive sectors like utilities, real estate, healthcare and consumer staples. ETFs from these sectors like Utilities Select Sector SPDR XLU, Vanguard Real Estate ETF VNQ, iShares U.S. Healthcare Providers ETF IHF, Invesco Dynamic Food & Beverage ETF (PBJ) and Invesco Defensive Equity ETF DEF look excellent choices.
Why Defensive Sectors?
Being a low-beta sector, utility is relatively protected from large swings (ups and downs) in the stock market and is thus considered a defensive investment or a safe haven amid economic or political turmoil. Real estate also acts as a safe haven in times of market turbulence and concurrently offers higher returns with their juicy yields.
Healthcare, which generally outperforms during periods of low growth and high uncertainty, garnered investors’ interest owing to its non-cyclical nature. The consumer staples sector also sees steady demand in the wake of an economic downturn on account of its less correlation with the economic cycles. It generally acts as a safe haven amid political and economic turmoil.
Recession Might Be in Cards!
In a fight to curb inflation, Fed Chair Jerome Powell raised interest rates by another 75 bps in the meeting that concluded this week. This marks the third consecutive rate hike of 0.75% and pushed the benchmark interest rate to 3.0-3.25%, the highest level since 2008 (read: ETFs That Won After Fed Rate Hike).
The central bank also signaled that additional large rate hikes were likely at upcoming meetings as it combats inflation that remains near a 40-year high. Fed officials now expect the federal funds rate at a range of 4.25% to 4.5%, a full percentage point above the 3.25% to 3.5% projected in June to end 2022. This means that the central bank could approve another three-quarter point hike at its November meeting and then a half-point rate rise in December.
Economists warned that the effects of rapid tightening would be felt across the labor, housing and stock markets, thereby pulling the economy into recession. This is especially true as the Fed officials expect the unemployment rate to rise to 4.4% next year from the current 3.7%, while GDP growth to slump to just 0.2% for 2022. According to Omair Sharif, founder of Inflation Insights, “the U.S. economy has entered a recession every time the unemployment rate has risen by at least 50-bps in the last 75 years.”
The housing market are cooling off with mortgage rates skyrocketing to a 14-year high at 6.25%. The increase in rates has made home ownership more expensive for first-time buyers, discouraging people from buying homes.
ETFs in Focus
Utilities Select Sector SPDR (XLU)
With an AUM of $17.8 billion, Utilities Select Sector SPDR seeks to provide exposure to companies from the electric utility, water utility, multi-utility, independent power and renewable electricity producers, and gas utility industries. XLU follows the Utilities Select Sector Index, holding 29 stocks in its basket. Electric utilities take the top spot among sectors at 63.8%, closely followed by multi utilities (30.5%).
Utilities Select Sector SPDR charges 10 bps of annual fees and sees a heavy volume of 10.8 million shares, on average. XLU has a Zacks ETF Rank #3 (Hold) with a Medium risk outlook (read: Can the Rally in Utilities ETFs Last?).
Vanguard Real Estate ETF (VNQ)
Vanguard Real Estate ETF follows the MSCI US Investable Market Real Estate 25/50 Index and holds 167 stocks in its basket. Specialized REITs take the largest share at 38.7%, while residential REITs, industrial REITs and retail REITs round off the next three with double-digit exposure each. The expense ratio comes in at 0.12%.
Vanguard Real Estate ETF is the most popular and liquid ETF with an AUM of $36.5 billion and an average daily volume of 4 million shares a day. VNQ has a Zacks ETF Rank #2 (Buy) with a Medium risk outlook.
iShares U.S. Healthcare Providers ETF (IHF)
iShares U.S. Healthcare Providers ETF provides exposure to companies that offer health insurance, diagnostics and specialized treatment. IHF follows the Dow Jones U.S. Select Healthcare Providers Index.
iShares U.S. Healthcare Providers ETF holds 72 securities in its basket and amassed $1.6 billion in its asset base. Volume is good at about 63,000 shares per day, on average. IHF charges 39 bps as annual fees and has a Zacks ETF Rank #2 with a Medium risk outlook.
Invesco Dynamic Food & Beverage ETF (PBJ)
Invesco Dynamic Food & Beverage ETF offers exposure to 31 stocks engaged in manufacturing, selling or distributing food and beverage products, agricultural products and products related to the development of new food technologies by tracking the Dynamic Food & Beverage Intellidex Index (read: 4 ETFs to Gain From Hotter-Than-Expected Inflation).
With an AUM of $326.9 million, Invesco Dynamic Food & Beverage ETF charges 63 bps worth of annual fees from investors and sees a moderate average daily volume of 87,000 shares. PBJ has a Zacks ETF Rank #3 with a Medium risk outlook.
Invesco Defensive Equity ETF (DEF)
Invesco Defensive Equity ETF offers exposure to companies that potentially have superior risk-return profiles during periods of stock market weakness while still offering the potential for gains during periods of market strength. It tracks the Invesco Defensive Equity Index and holds 101 stocks in its basket.
Invesco Defensive Equity ETF accumulated $250.2 million in its asset base and saw a lower volume of 20,000 shares per day, on average. DEF charges 55 bps in fees per year and has a Zacks ETF Rank #3 with a Medium risk outlook.
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Vanguard Real Estate ETF (VNQ): ETF Research Reports
Utilities Select Sector SPDR ETF (XLU): ETF Research Reports
iShares U.S. Healthcare Providers ETF (IHF): ETF Research Reports
Invesco Defensive Equity ETF (DEF): ETF Research Reports
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