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Amid the latest rally, investors are flocking to defensive sectors like utilities and consumer staples in search of cheap stocks and away from cyclical sectors like technology and consumer discretionary. The strategy of shifting investments from one sector of the economy to another in anticipation of the next stage of the economic cycle is called sector rotation. It aims to capitalize on the relative strength of different sectors at different stages of the economic cycle.

While there are a number of ETFs to tap sector rotation, five popular funds seem to be the most exciting picks. These are Utilities Select Sector SPDR (XLU - Free Report), Vanguard Utilities ETF (VPU - Free Report), iShares U.S. Utilities ETF (IDU - Free Report), Consumer Staples Select Sector SPDR Fund (XLP - Free Report) and Vanguard Consumer Staples ETF (VDC - Free Report). All these have a favorable Zacks ETF Rank #3 (Hold). 

Why is Sector Rotation Taking Place?

Investors are on the hunt for value stocks, which have underperformed the leading technology names. According to Wall Street strategists, the utility sector entered March trading at its largest discount to the S&P 500 from a valuation standpoint (using a forward price-to-earnings ratio) since 2009. Also, consumer staples had underperformed the S&P 500 by almost 30% over the last year. This presented a potential buying opportunity in both traditionally "defensive" sectors.

Additionally, the world's largest economy is showing signs of a slowdown, highlighted by a weaker-than-expected jobs report and contraction in manufacturing activity for the month, thus raising bets for defensive investments. The economy expanded at the slowest pace in two years, with GDP rising 1.6% annually in the first quarter. Being a low-beta sector, both sectors are relatively protected from large swings (ups and downs) in the stock market and are considered defensive investments or safe havens amid economic or political turmoil. Stocks in these sectors generally outperform during periods of low growth and high uncertainty.

As utilities require huge infrastructure, which creates a massive debt burden and interest obligation, the Fed’s “no rate hike” memo lifted the stocks in the space. Meanwhile, the consumer staples space includes a variety of items like food & beverages, non-durable household goods, hypermarkets and consumer supercenters that are essential for daily needs. These products see steady demand even during an economic downturn due to their low level of correlation with economic cycles.

ETFs to Tap

Utilities Select Sector SPDR (XLU)

With an AUM of $13 billion, Utilities Select Sector SPDR seeks to provide exposure to companies from the electric utility, water utility, multi-utility, independent power and renewable electricity producers, and gas utility industries. XLU follows the Utilities Select Sector Index, holding 31 stocks in its basket. Electric utilities take the top spot among sectors at 65.6%, closely followed by multi utilities (26.2%).

Utilities Select Sector SPDR charges 9 bps of annual fees and sees a heavy volume of 14 million shares, on average. XLU has rallied about 9% over the past month.

Vanguard Utilities ETF (VPU)

Vanguard Utilities ETF follows the MSCI US Investable Market Utilities 25/50 Index, holding 65 securities in its basket, with none accounting for more than 12% share. More than half of the portfolio is allocated to electric utilities, closely followed by multi utilities (25.4%).

Vanguard Utilities ETF charges 10 bps in annual fees and sees a good volume of around 171,000 shares on average. It has AUM of $5.5 billion and is up 8.6% in a month.

iShares U.S. Utilities ETF (IDU)

iShares U.S. Utilities ETF tracks the Russell 1000 Utilities RIC 22.5/45 Capped Index. It holds a basket of 46 securities with a slight tilt toward the top firm at 12%, while others make up for less than 7%. Here again, electric utilities dominate the portfolio at 57%, followed by multi utilities (22.3%).

iShares U.S. Utilities ETF has amassed $1 billion in its asset base while trading in a good volume of 48,000 shares a day on average. The fund charges 40 bps in annual fees and has gained 8% in a month.

Consumer Staples Select Sector SPDR Fund (XLP)

Consumer Staples Select Sector SPDR Fund offers exposure to companies primarily involved in the development and production of consumer products that cover food and drug retailing, beverages, food products, tobacco, household products, and personal products. It follows the Consumer Staples Select Sector Index and holds 38 stocks in its basket.

Consumer Staples Select Sector SPDR Fund is the most popular consumer staples ETF with AUM of $15 billion and an average daily volume of 12 million shares. It charges 9 bps in annual fees and has gained 4% in a month.

Vanguard Consumer Staples ETF (VDC)

Vanguard Consumer Staples ETF also targets the broad consumer staples space by tracking the MSCI US Investable Market Consumer Staples 25/50 Index. It holds 103 stocks in its basket, with double-digit concentration on the top two firms.

Vanguard Consumer Staples ETF manages a $6.6 billion asset base and charges a fee of 10 bps per year. VDC trades in a good average volume of around 98,000 shares per day and has gained nearly 4% in a month.

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