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Minimize Volatility with These Two ETFs

June 20, 2012 | About:
The S&P 500 has given up 7 percent since peaking in April 2012, primarily because of uncertainty regarding Greece’s commitment to the terms of its bailout.

If a second round of elections in Greece on June 17 fails to produce a government — or if anti-austerity factions gain control — the stage will be set for the country to exit the euro, with a potentially disastrous dom­ino effect across the continent. The U.S. also faces economic and fiscal challenges, as well as its own contentious elections in November.

The likelihood of further downside for the stock market has driven up the Chicago Board Options Exchange Market Volatility In­dex (VIX), a measure of the implied volatility of S&P 500 index options. Often re­ferred to as the “fear index,” the VIX portrays the market’s expected volatility over the next 30 days. The indicator should push higher in coming months, making this a good time to play defense.

On the Defensive

Investors haven’t given utility stocks much love in 2012. Whereas higher-risk sectors such as consumer discretionary, technology and fi­nancials have posted impressive gains this year, the utilities sector has actually declined by 0.9 percent.

However, that trend is reversing. Utilities Select Sector SPDR (XLU) gained 1.8 percent in April and a further half percent in May, as investors began looking for safe havens. After a warmer-than-usual winter, the National Oceanic and Atmospheric Administration predicts above-average summer temperatures for more than half the US, presaging a spike in electricity consumption.

Electric utilities account for more than 55 percent of Utilities Select Sec­tor SPDR’s investable assets, provid­ing ample upside exposure to recov­ering electricity demand. With a beta of 0.31, the exchange-traded fund (ETF) exhibits less volatility than the S&P 500. It also offers a 3.9 percent dividend yield.

Health care stocks also held up well during the recent sell-off. Most health care companies are extremely cash heavy, funding a 37 percent year-over-year boost in share buybacks during the first quarter. Moreover, robust de­mand in emerging markets is buoying the sector. China in particular has ex­perienced strong growth in health care spending, as it works towards imple­menting universal health insurance by 2020.

The technology sector — the year’s highest flier and one of the most ec­onomically sensitive — also has been surprisingly resilient during the re­cent sell-off.

Despite its 0.87 percent beta, Technology Select Sector SPDR (XLK) has only captured about half of the broader S&P 500’s downside. The fund also is cheap on a forward valuation basis, with a price-to-earnings growth ratio of just 0.92.

About the author:

Benjamin Shepherd
Investing Daily provides stock market advice and investment newsletters to help independent investors achieve a secure and rewarding financial future. The site’s coverage focuses on finding the most profitable emerging trends in the investment universe to bring investors pragmatic and in-depth coverage of the names that are taking advantage of these opportunities.

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