If I Could Only Own 3 Funds For The Next Recession

The markets have experienced considerable volatility recently as they have grappled with differing messages from macroeconomic data releases recently. Some of this data seems to indicate that the economy is headed for a soft landing. Other data, such as rising unemployment, soaring consumer credit card debt, increasing credit card delinquencies, weakening consumer confidence, and a still-inverted yield curve when comparing the federal funds rate to the 10-year Treasury yield (US10Y), suggest a recession. With that risk in mind, it may be prudent for conservative income-focused investors to batten down the hatches in preparation for an economic downturn.

So my income stream and capital do not suffer during a potential market crash and/or economic downturn leading to dividend cuts, here are three ETFs that I would buy if I could only buy three for the next recession:

Fund #1

The first fund that, I think, is a must-own for income-focused investors is a gold ETF that delivers passive income cash flow. For those purposes, my first preference would be to buy the SPDR Gold Shares ETF (GLD). I would sell covered calls and puts against it to generate passive income while enjoying the strong ballast for my portfolio that gold will likely provide during the upcoming rate-cutting and geopolitically tense cycle. The fact that the Federal Reserve is growing increasingly dovish and that the U.S. government appears likely to continue spending at a breakneck pace, regardless of which party wins power in the upcoming election, suggests that gold is likely going to enjoy strong tailwinds for the foreseeable future. If the wars in Europe or the Middle East escalate, or if China makes more overt moves towards Taiwan, gold is likely to shoot higher as well, even as the broader market falls. This could enable investors to eventually recycle some capital from gold into high-yielding dividend stocks on an opportunistic basis, and if not, at the very least, they can continue to enjoy the attractive options income.

Another option for those who do not want to put in the work themselves is to simply buy the Credit Suisse X-Links Gold Shares Covered Call ETN (GLDI). This does its own notional covered call writing strategy and delivers passive income to investors on a monthly basis. That said, I prefer GLD due to lower expenses and its vastly superior long-term track record. It also offers additional control by allowing shareholders to determine when and where to write their calls and puts on their underlying GLD position.

Fund #2

The next ETF I would buy among the three for the next recession would be the Utility Sector Select Sector SPDR Fund ETF (XLU). While its dividend yield of about 3% is not exactly stellar, and the stock has been on a tremendous run recently, making it less attractive from a valuation standpoint, the expense ratio is just 0.09%. XLU is highly likely to benefit from Federal Reserve rate cuts. The regulated utility business models of its underlying holdings are likely going to perform very well relative to other stocks and companies in a recessionary environment. Additionally, with the growing demand for artificial intelligence, the sector should enjoy a strong tailwind from rapidly growing power demand.

Fund #3

Finally, the third ETF I would buy would be either the Alerian MLP ETF (AMLP) or the Global X MLP ETF (MLPA). The reason I would favor AMLP is that it has a higher dividend yield of 7.8% compared to MLPA’s 7.4%. However, MLPA has a lower expense ratio going for it of just 0.45% compared to AMLP’s 0.85%. Meanwhile, both of their underlying holdings are fairly similar, with significant exposure to the likes of Energy Transfer (ET), Enterprise Products Partners (EPD), MPLX (MPLX), and Plains All American (PAA) as their top four holdings—all of which are strong blue chips that combine attractive current yields with solid distribution growth and strong balance sheets.

I like the midstream sector because it offers a very attractive dividend yield along with growth that is likely going to beat inflation for the foreseeable future. It also has highly contracted and even in some cases regulated underlying cash flows that should be quite defensive in the face of a recession. As a result, it can provide a higher yield that can balance XLU’s lower yield while still providing strong defensiveness against a recession. Additionally, these ETFs should benefit from growing energy demand due to the AI boom and other economic growth factors, as well as the systemic underinvestment in fossil fuel production.

Investor Takeaway

Combining these three funds sets up investors to benefit from numerous macro trends. They should hold up quite well during an economic downturn while still delivering very attractive passive income for income-focused investors that can be counted on through thick and thin.

I, personally, favor picking individual stocks, especially in these sectors, which has helped fuel my significant outperformance of the market recently. However, investing in funds like the ones mentioned in this article is not a bad approach for investors who prefer taking a more hands-off approach. You can enjoy the vast diversification that comes from ETF investing yet still tilt your portfolio more defensively.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.