Comparing Utilities vs all other S&P 500 Sectors

VTS Community,

Defensive Rotation Strategy:  Why do we use Utilities?

If you've been following VTS for any length of time, I'm sure you've noticed that there are days where our "safety" positions don't actually feel like safety positions.  Sometimes it even feels like they are underperforming what would happen if we just stayed in the aggressive position instead.

Have you had that thought following my strategies?

One of the MANY benefits to investing the way I do, rules based, systematic, tactical rotation, is that I can very easily just show alternatives and we can make sure we're in the best positions.  It doesn't mean it works every time, obviously nothing does, but long-term I can be mathematically sure I'm allocated to the right positions.

Let's answer Aaron's question and you'll see what I mean:

Aaron says:  "When comparing XLU, XLF, and XLE at different times, I noticed each of the outperform the other two at different times" 

Thank you for the question Aaron, and I can do you one better.  How about I show you ALL of the sector ETFs for the entire S&P 500?

The baseline:

What would happen in the Defensive Rotation Strategy if instead of moving to XLU Utilities for "safety" we instead just maintained our 2x Nasdaq QLD positions?  As in, what if we just didn't bother moving to safety at all?

* Remember, our safety positions are during mid-high Volatility and those account for 15.31% of trading days.

We can see XLU Utilities performance is very good.  Getting 4.33% CAGR out of just 15% of trading days, with a maximum drawdown of less than 10%, that's well worth it.

Maintaining the QLD Nasdaq on the other hand is a disaster.  Not only is there no return, but the drawdown is insane.  

It's easy to see why we move to safety right?

In fact it's impossible to find a better performer than Utilities, but let's try

Using XLK technology sector

This is similar to the 2x Nasdaq QLD except it's just 1x with no leverage.

This is slightly better in that there is a positive 1% return, but the maximum drawdown is still 30%.  That's a terrible risk reward ratio.

Using XLV healthcare sector

The Healthcare sector is actually a pretty good performer within the S&P 500, but the real question is, how does it do only as a safety asset during higher Volatility periods?

Well better than the technology sector, but that's still a very large drawdown for such a small boost in performance.

You'll notice this as a running theme here...

Using XLF financials sector

Banks don't exactly scream "safety" positions do they?

There may be a time and a place to get aggressive investing in the financial sector, but trying to avoid drawdowns is not one of them.

Using XLP consumer staples sector

This certainly sounds like a sector that might be safer than the others right?  During a downturn in the stock market, people still need to buy their staples, so how does this one perform compared to Utilities?

Aside from one rough period in 2022, which let's be honest every major asset also struggled during that time, but consumer staples are decent.  Not worth using in our case, Utilities are far superior, but it's one to keep on an extended list to keep an eye on.

Using XLY discretionary sector

I guess people can skip out on a few purchases in this category in rough times so it probably doesn't offer much protection in a downturn.

There hasn't been any progress since 2015 with this one, next...

Using XLE energy sector

Here we have our first one that from a pure rate of return perspective is getting close to Utilities.

However, the point of "safety" positions is to reduce drawdowns in uncertain times.  While energy puts up some good return numbers, that's a 36.57% drawdown which is a complete non-starter.

Using XLI industrials sector

This is another sector where just rationally we would expect it to be pretty well insulated during downturns, and that turns out to be true in practise.

The drawdown is still more than double XLU Utilities, and the return isn't as high either so it's not like we would actually use this.  Having said that, safety positions are very hard to find, and I would rank industrials in the top 5 overall.

Using XLB basic materials sector

Often considered a safety position, but is it true in practise?

This one again had a rough 2022, but even without that it's just not good enough to consider in any of our strategies.

Using IYR real estate sector

The IYR Real Estate ETF is our safety position within the Strategic Tail Risk Strategy so I've talked about this one a lot.  The key point to remember is there is an interest rate sensitivity element to real estate.  That's the primary driver of that terrible performance in the last couple years, as interest rates have risen as fast as any point in history.  This is decidedly not good for this ETF.

However, if we only use IYR real estate during times when we aren't expecting interest rates to be increasing, then the performance is actually quite good.  Remember within Strategic Tail Risk, we had cash as our safety for a long time to avoid using IYR at the wrong time.  Bottom line, IYR can work well if you know when to use it.

Using GLD Gold

Just for a point of reference, let's show GLD Gold as well since we use this as our safety position in the Tactical Volatility Strategy

Not overly surprising here, but the performance is quite good as a safety position.  Turns out I do know what I'm doing here utilizing both of these in two different strategies  :)

Conclusion

Safety positions may not always perform well day to day, and like I said there will certainly be times when we question why we're even holding them.  It may feel like, why bother, let's just keep holding stocks right?

However, if these charts show you anything it should be this.  There can be EXTREME consequences to holding the aggressive positions at the wrong time.  They can see periods of huge drawdowns that will take way too long to recover from.  When it's time to get to the sidelines, the last thing in the world you want to do is move towards something that can crash just as much as stocks.

There's a reason why we use XLU Utilities, GLD Gold, and IYR real estate in all three of our tactical rotation strategies.  While they can be frustrating at times, they are clearly the best choices long-term.