Minimize Volatility With These 2 SPDR Sector ETFs

Includes: XLK, XLU
by: Benjamin Shepherd

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 US 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 (NYSE: 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 selloff. 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 selloff.

Despite its 0.87 percent beta, Technology Select Sector SPDR (NYSE: 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.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.