Three ETFs for the Market's Dog Days

06/01/2010 1:30 pm EST

Focus: ETFS

Richard Band

Editor, Profitable Investing

Richard Band, editor of Profitable Investing, says defensive stocks usually do well at this time of year, and he names three ETFs that will help you follow that trend.

Did we just witness the end of an important market chapter? I suspect so.

From March 2009 to this past April, the rising tide in the US stock market lifted virtually all boats. At the April peak, 98% of the 197 industry groups monitored by Investors Intelligence were in well-defined up trends. A market advance doesn’t get much more unanimous than that.

From now on, if history is any guide, Mr. Market will favor a much more selective set of stocks. With each periodic “correction,” more names will stumble and then recover haltingly, if at all. We want to concentrate our holdings in the sectors and individual stocks that will participate to the fullest in the bull market as it matures.

Which sectors should you focus on now? It looks to me as if 2010 is shaping up as a more or less “normal” year—strong at the beginning, soft in the middle (May through October) and, we hope, buoyant at the end. Since 1945, the Standard & Poor’s 500 has returned an average of just 1.4% from May 1st to October 31st, versus 6.7% from November 1st to April 30th.

On that hunch, I recommend steering your dollars into sectors that have historically fared better than their peers during the lackluster middle months of the year. Here are my top picks, in descending order:

iShares Dow Jones US Pharmaceuticals ETF (NYSEArca: IHE). Drug stocks are well-positioned to outperform the market in the months ahead. Profits are largely insulated from the ups and downs of the economic cycle, and in any case, earnings projections for the major US pharmaceutical makers are pointing firmly upward in 2010. Washington’s recently passed health care legislation won’t derail this trend. Current yield: 1.3%.

Consumer Staples Select Sector SPDR (NYSEArca: XLP). This ETF holds giant stakes in Procter & Gamble (NYSE: PG) and Wal-Mart Stores (NYSE: WMT)—together, 26% of the fund’s assets.

During the first four months of the year, these and other “staples” stocks were wallflowers, lagging the S&P by about two points. Since May 1, however, the advantage has swung the other way. I think staples will at least match the market over the summer and early autumn months, and may do considerably better. Current yield: 2.6%.

Utilities Select Sector SPDR (NYSEArca: XLU). For the Nervous Nellies among us (I’m one!), this collection of 38 electric and gas utilities yields an ample 4.1%. The plump dividend, paid quarterly, not only helps support the share price but also furnishes you with extra cash to invest along the way as you please.

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