Investors have been worried about a recession since the Federal Reserve significantly hiked interest rates in 2022. In fact, last July, people betting on Kalshi assigned a probability of over 40% that a recession would materialize in 2025.
But as recently as early February of this year, the odds of a recession had plummeted to below 20%. Since then, the likelihood of a recession this year has rebounded to 28% (as of April 1), although it had been nearly 37% just two days prior. Keep in mind that these probabilities change frequently. The recent surge occurred due to a string of poor economic data and the Iran war, which has driven oil prices significantly higher.
Kalshi defines a recession using the U.S. Bureau of Economic Analysis’ definition: two consecutive quarters of negative U.S. gross domestic product (GDP) growth. This is certainly not out of the question. Fourth-quarter U.S. GDP was revised down to 0.7% in March.
Investors should keep in mind that the stock market may not struggle as much as people think if there are two quarters of slightly negative GDP. Sure, it might cause some concern initially, but the Federal Reserve would likely be able to cut interest rates in such a scenario, and if GDP turns positive after just two quarters, it would likely be considered only a shallow recession.
That said, it’s perfectly understandable if investors are concerned and want to hedge their downside risk if a recession materializes. Here are two exchange-traded funds (ETFs) to buy to prepare for such a scenario.
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State Street Consumer Staples Select Sector SPDR ETF
When investors hear about a recession, the first sector that comes to mind is consumer staples. The State Street Consumer Staples Select Sector SPDR ETF (XLP +0.53%) has exposure to companies focused on distribution and retail, household products, food, beverages, tobacco, and personal care. These products are considered more resilient in a tough economy because they are a core part of consumers’ budgets.
For instance, even when budgets are constrained, consumers are much less likely to cut back on essentials like toothpaste and food. XLP is most exposed to consumer staples distribution and retail, which comprises over 33% of the ETF’s capital. The next-largest sectors are beverages and food. Here are the top five holdings in the ETF by weight:
Walmart — 11.85%
Costco — 9.68%
Procter & Gamble — 7.36%
Coca-Cola — 6.46%
Philip Morris International — 5.61%
XLP has done a good job navigating the chaos so far this year. While most major market indexes slipped into correction territory, at least briefly, XLP has risen 5%. The ETF is roughly flat over the past year and up 20% in the last five years.
Vanguard Utilities ETF
Utilities are companies responsible for distributing electricity, water, or gas, or for generating power independently, and it’s a similar theme to consumer staples in that people need water to survive and power to live comfortably. Utilities are inelastic, essentially meaning people will pay for them, regardless of price, unless they simply don’t have the money to cover the cost.
Vanguard Utilities ETF
Today’s Change
(0.59%) $1.17
Current Price
$200.14
Key Data Points
Day’s Range
$198.48 – $200.99
52wk Range
$154.00 – $206.10
Volume
225K
Electric utilities make up over 62% of the Vanguard Utilities ETF (VPU +0.59%), while multi-utilities make up 24%. Here are the top five holdings in the ETF by weight:
NextEra Energy — 11.95%
Southern — 6.38%
Duke Energy — 6.30%
Constellation Energy — 6.29%
American Electric Power — 4.42%
VPU has also generated a roughly 5% return this year. The ETF is up roughly 15% over the past year, and about 40% over the past five years. Consumer staples and utilities are not high-growth stocks, so during a bull market, they are unlikely to be huge winners. However, it’s when investors are panicking, and there are concerns about a recession, that these sectors usually pay off.
Long-term investors don’t need to be overweight in consumer staples or utilities, but having some exposure can hedge your downside during difficult market conditions.
Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Constellation Energy, Costco Wholesale, NextEra Energy, and Walmart. The Motley Fool recommends Duke Energy and Philip Morris International. The Motley Fool has a disclosure policy.