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Get Tactical With Defensive Staples ETFs

This article was originally published on ETFTrends.com.

The Consumer Staples Select Sector SPDR ETF (XLP) , the largest exchange traded fund tracking the consumer staples sector, and rival cap-weighted staples ETFs are rallying to start 2019 as some investors embrace defensive sectors.

XLP provides “exposure to companies from the food and staples retailing, beverage, food product, tobacco, household product and personal product industries in the U.S.,” according to State Street.

With the business cycle potentially slowing next year, defensive sectors could be embraced by investors. Consumer staples, health care and industrial sectors typically outperform during the so-called slowdown period of a business cycle when economic growth starts decelerating but remains positive, the economy runs beyond its full capacity and monetary policy becomes restrictive.

“Consumer Staples has been one of the least-favored sectors since mid-2016, underperforming the broad market by 16% annually as interest rates rose and economic growth accelerated,” said State Street in a note out Friday. “However, as long-term interest rates have started to head south on the backdrop of decelerating growth prospects, Consumer Staples have played a good defense in the equity market.”

Looking Ahead for XLP ETF

Investors typically shift into consumer staples during bouts of market volatility because of the sector’s relatively generous dividend payouts and the slow-and-steady nature of the consumer staples business – consumers usually continue purchase basic products that staples firms sell regardless of market or economic conditions.

XLP is home to 33 stocks with a weighted average market capitalization of $123 billion. The fund has a dividend yield of 2.99 percent. Historically, declining Treasury yields benefit the consumer staples sector.

“As shown below, the sector’s relative performance to the broad market has moved in the opposite direction of long-term yields,” said State Street. “Since December 2007, the Consumer Staples sector outperformed the broad market by 0.95% on a monthly average two-thirds of the time when yields on the 10-year Treasury fell.”

Related: How to be a Value Investor Without Picking Stocks

The sector also displays quality characteristics. Valuing high quality value is particularly important as bull markets enter their waning stages, as some market observers believe the current bull market is doing. In the early stages of bull markets, lower quality companies see their shares soar. However, as the bull matures, investors often exhibit a preference for higher quality fare with more compelling valuations.

“The Consumer Staples sector has historically shown quality traits, such as higher return on equity and sufficient free-cash-flow-to-debt ratio. With less elastic products, Consumer Staples companies are more capable of passing on increasing input costs to consumers to maintain stable margins or navigate a slowdown in economic growth,” according to State Street.

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