The U.S. stock market may have rallied in the first half of 2023 thanks to hype from the rapid pace of artificial intelligence growth in the technology sector, but the prospect of an imminent recession still looms over many investors.
“A recession is defined as two consecutive quarters of negative gross domestic product, or GDP, growth,” says Dan Tolomay, chief investment officer at Trust Company of the South. “In other words, if economic output shrinks for a six-month period, it signals an official recession.”
As of June 20, the yield curve remains inverted, with short-term bond yields sitting well above their long-term counterparts. Historically, an inverted yield curve has preceded many past recessions, and is regarded by economists as a sign of a pessimistic economic outlook.
There are also worries that aggressive consecutive interest rate hikes by the U.S. Federal Reserve, or Fed, may have set up the economy for a “hard landing,” or an impending recession. On June 14, the Fed elected to hold rates steady at its latest policy meeting out of an abundance of caution and restraint.
So, what does the possibility of a recession mean for retail investors?
“Lower economic activity can lead to layoffs as companies try to control expenses in the face of fading revenue, while lesser demand paired with higher unemployment means lower sales,” Tolomay says. “As economic activity slows, companies’ prospects dim, and stock prices follow downward.”
Still, not all investments are equally susceptible to the effects of inflation. While more speculative sectors like technology and riskier assets like high-yield bonds may be hit particularly hard, some have historically proven to be more resilient.
“High-quality bonds like U.S. Treasurys tend to perform better when stocks are declining,” Tolomay says. “Within the equity market, defensive sectors like consumer staples, health care and utilities may hold up better as demand for their products and services remains more consistent even in a downturn.”
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Here’s a look at nine exchange-traded funds, or ETFs, that could be good buys in preparation for a recession:
| ETF | Expense Ratio |
| iShares U.S. Treasury Bond ETF (ticker: GOVT) | 0.05% |
| Vanguard Short-Term Treasury ETF (VGSH) | 0.04% |
| iShares 0-3 Month Treasury Bond ETF (SGOV) | 0.05% |
| Vanguard Long-Term Treasury ETF (VGLT) | 0.04% |
| The Consumer Staples Select Sector SPDR Fund (XLP) | 0.1% |
| The Utilities Select Sector SPDR Fund (XLU) | 0.1% |
| The Health Care Select Sector SPDR Fund (XLV) | 0.1% |
| Invesco Defensive Equity ETF (DEF) | 0.54% |
| Invesco S&P 500 High Dividend Low Volatility ETF (SPHD) | 0.3% |
iShares U.S. Treasury Bond ETF (GOVT)
A straightforward and transparent ETF for accessing a diversified portfolio of Treasury bonds
is GOVT. By tracking the IDC US Treasury Core Index, GOVT provides exposure to 145 Treasurys ranging in maturities from under one year to over 20 years for a low 0.05% expense ratio, or $5 per year on a $10,000 investment.
Currently, GOVT sports an average duration of 6.2 years. All else being equal, a 100-basis-point cut in rates will result in the ETF gaining 6.2%, and vice versa should rates rise. Currently, GOVT pays a weighted-average yield to maturity of 4.3%, which is the theoretical yield an investor can expect if all of its Treasurys were held until maturity.
Vanguard Short-Term Treasury ETF (VGSH)
While the Fed has historically cut rates during recessions, there’s no guarantee of this occurring in the future. For the time being, the Fed has indicated that future rate hikes may be on the way after the recent pause, depending on how inflation fares. To combat this, a short-term Treasury ETF could work.
With an average duration of 1.9 years, VGSH is less sensitive to rate hikes. Should rates rise by 100 basis points, VGSH is expected to lose just 1.9%, all else being equal. Thanks to the current inverted yield curve, the ETF is paying a higher average yield to maturity of 4.5%. VGSH charges a 0.04% expense ratio.
iShares 0-3 Month Treasury Bond ETF (SGOV)
Investors looking for a virtually risk-free ETF pick that eliminates both interest rate and credit risk can consider SGOV. This ETF tracks Treasury bills, or T-bills, with maturities of three months or less. Regarded as the “risk-free” asset, T-bills don’t lose much value when rates rise and aren’t at risk of default.
In fact, as rates rise, the yields offered by T-bills increase in lockstep. Thanks to this and the inverted yield curve, SGOV is paying out a very competitive average yield to maturity of 5.1% against a low duration of just 0.1 years. All this comes at a remarkably affordable 0.05% expense ratio.
Vanguard Long-Term Treasury ETF (VGLT)
Investors looking to bet on the prospect of dramatic rate cuts when a recession strikes can juice their potential returns via an ETF that holds long-term Treasurys, like VGLT. This ETF holds a portfolio of Treasurys that mostly have maturities above 15 years for a 0.04% expense ratio.
As a result, VGLT currently sports a high average duration of 16 years. Should the Fed slash rates by 100 basis points during a recession, VGLT can be expected to gain 16%, all else being equal. However, due to the inverted yield curve, the ETF is paying a lower yield to maturity of 4% right now. In contrast to the shorter-duration bond ETFs mentioned above, VGLT would not be a good holding in a recession that came as rates were rising. Rather, it’s best owned when rates are set to fall as the Fed seeks to support the economy by slashing rates.
The Consumer Staples Select Sector SPDR Fund (XLP)
“A recession typically comes with high unemployment, a contracting GDP and lower consumer spending,” says Richard Gardner, CEO at Modulus Global, a provider of advanced trading and exchange software. “Because of that, investors tend to be more risk-averse, and look toward safer equity sector industries to park their money to ride out the recession.”
A traditionally defensive sector is consumer staples, and a great way of indexing the top consumer staples stocks is via XLP. This ETF tracks the 37 large-cap stocks that represent the consumer staples sector in the broader S&P 500 index for a 0.1% expense ratio.
[READ: 7 Stocks That Outperform in a Recession.]
The Utilities Select Sector SPDR Fund (XLU)
“Historically, the utilities sector has performed comparatively well during recessions,” Gardner says. “For example, most people don’t stop using electricity just because the economy is bad.” This inelastic demand
can help utilities companies weather downturns better than more cyclical counterparts.
To access 30 of the largest utilities sector stocks in the S&P 500, investors can buy XLU. This ETF contains companies from the electric, water utility, renewable electricity and gas utility industries. Like the rest of State Street’s “Select Sector” lineup, XLU charges a 0.1% expense ratio.
The Health Care Select Sector SPDR Fund (XLV)
Another historically recession-resilient sector is health care, again due to inelastic demand for its services and products. Even when times are tough, these companies can benefit from government spending. The long-term effects of an aging population can provide structural tailwinds as well.
Thus, investing in companies that manufacture and provide pharmaceuticals, health care equipment, services and technology could be a way to tilt an equity portfolio defensively. The ETF to consider here is XLV, which tracks 65 health care stocks represented in the S&P 500 for a 0.1% expense ratio.
Invesco Defensive Equity ETF (DEF)
A unique ETF to consider from Invesco is DEF, which as its name suggests has a defensive equity focus. The ETF tracks the Invesco Defensive Equity Index, which uses a rules-based strategy to select stocks with better risk-adjusted returns during periods of market weakness.
Unlike the previous equity ETFs, DEF is diversified across sectors, with its largest allocations in health care, financials and industrials. The ETF also has a significant tilt toward mid-cap stocks, compared to the large-cap focus of the Select Sector ETFs. DEF charges a 0.54% expense ratio.
Invesco S&P 500 High Dividend Low Volatility ETF (SPHD)
During a recession, investors tend to flee high-volatility growth stocks in favor of lower-volatility, dividend-paying companies. This approach can provide a combination of better stability and higher income. An ETF that embodies this strategy is SPHD, which tracks the S&P 500 Low Volatility High Dividend Index.
Currently, SPHD’s portfolio tracks about 50 S&P 500 stocks that have historically provided both high dividend yields and low volatility. Unsurprisingly, utilities and consumer staples are the second- and third-largest sectors represented (real estate tops the list). The ETF charges a 0.3% expense ratio and pays a 30-day SEC yield of 4.8%.
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9 Best ETFs to Buy for a Recession originally appeared on usnews.com
Update 06/21/23: This story was previously published at an earlier date and has been updated with new information.
