XLP: Getting Defensive Ahead of Market’s Worst Months

With August’s close, the summer doldrums are nearly over.  

What’s next and which exchange-traded funds have momentum? The worst months of the year and defensive sector ETFs, respectively. 

Over the past month, traditional defensive areas, including utilities, consumer staples, and healthcare stocks are beating the S&P 500 index, as measured by the respective ETFs, the Utilities Select Sector SPDR Fund (XLU), the Consumer Staples Select Sector SPDR Fund (XLP), and the Health Care Select Sector SPDR Fund (XLV). 

The potential for these defensive areas to continue their momentum may rise as September and October are infamous for being challenging for the stock market. 

Historically, after the summer months, investors and traders return from vacations, often reassessing their portfolios and adjusting positions, which can lead to volatility and market downturns. 

Actively managed funds, corporations, and investors may also begin to sell off losing positions in September to balance their portfolios before the fiscal year-end, leading to increased selling pressure. 

Some of the biggest stock market crashes in history, including the 1929 crash (beginning of the Great Depression) and the 1987 crash (Black Monday), occurred in October. This has created a psychological effect where investors become more cautious and defensive during this month. 

XLP: Investing in the Cautious Consumer 

For investors looking for a single-fund approach to defensive investing, consumer staples ETFs like XLP offer investors a diversified solution, as its holdings include companies that produce and sell essential goods and services, including food, beverages, household products, and personal care products. 

What makes XLP potentially attractive in 2024 is that consumer sentiment remains strong but with signs of weakness. For example, both the Conference Board's Consumer Confidence Index and the University of Michigan's Index of Consumer Sentiment have risen in recent months, indicating increased optimism among consumers. 

But a caveat in these reports is that consumers are still concerned about the economy, particularly regarding inflation and the labor market. 

In translation, consumers have money to spend but they may grow more cautious in the months ahead and cut spending on non-essential items like smartphones and travel, and stick to the essentials like groceries and prescription drugs.