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Commodities' strength this year isn't surprising because they do best in the late stage of the business cycle when inflation runs hot and inflation-wrangling hasn't yet dinged demand. Toss global supply disruption due to the War in Ukraine into the mix, and the recipe for gains has been perfect.

Unfortunately, commodities' safe-haven status may be waning.

Over 20 years ago I was a partner in a sell-side firm that did a lot of research on sector price trends. It stuck with me. I still track price performance for major sector exchange-traded funds to help me focus on the best baskets for new ideas. Lately, this research has been pointing me away from late-stage groups like energy to recessionary-stage sectors.

Specifically, while the Invesco Commodities ETF  (DBC)  is up 7.7% in the second quarter, its performance has lagged the market since the S&P 500 bottomed on May 20 and June 17. The situation is similar for the Energy Select SPDR ETF  (XLE) . Its swoon last week turned its quarter-to-date performance negative. It's still up 14% more than the S&P 500 this quarter, but it's lagging the S&P 500 since May 20 and June 17. The Oil & Gas Equipment SPDR  (XES)  has done worse. Following its recent sell-off, it's now trailing the S&P 500 this quarter, and since May 20 and June 17 (see table further below).

The recent underperformance suggests investors are rotating away from late-stage inflation plays like energy into defensive groups that do best during a recession.

Is it time to overweight healthcare?

Early cycle baskets like technology and finance do poorly when inflation crimps corporate margins and consumer wallets shrink. However, healthcare stocks tend to lead in the late stage of the cycle because worry over Fed-induced recession climbs alongside inflation; the group also leads in a recession because investors flock to stocks that are inelastic to economic activity, such as drugmakers.

Healthcare's recent momentum suggests investors are shifting more dollars toward it. 

The Healthcare Select SPDR ETF  (XLV)  is only down 9% in Q2, which is about 8% better than the S&P 500. It's trailing the S&P 500 slightly since May's low, but its 4.1% gain since June 17 is 1.8% better than the S&P 500 and 2% better than the Technology Select SPDR ETF.

Biotech is doing even better. 

Note: I track two biotech ETFs, the iShares Biotech ETF  (IBB,)  and the Select Biotech SPDR  (XBI,)  because their holdings and portfolio weights differ (the IBB is more heavily weighted toward large-cap biotech).

The IBB has outperformed the S&P 500 quarter-to-date, since May 20, and since June 17. The XBI lags quarter-to-date, but like the IBB, it's also leading since the May and June lows. Its performance has been stellar during the past week, gaining 6.2% since June 17 – nearly 4% better than the S&P 500. The IBB is up 3.4% since last week's low, which is also nicely ahead of the market.

ETFs highlighted in green are outpacing the S&P 500.

ETFs highlighted in green are outpacing the S&P 500.

Indeed, it appears healthcare is benefiting from recent weakness in commodity stocks and the rising risk of a recession caused by interest rates climbing faster than anticipated.

It's not just healthcare

Healthcare isn't the only recessionary basket that's gaining ground lately. The Select Utilities SPDR ETF  (XLU)  tumbled following May's low, yet it's still handily outpacing the market quarter-to-date, and it's up nearly 4% since June 17th. The Select Consumer Staples SPDR ETF  (XLP) , which has been hampered by exposure to Walmart  (WMT)  and Target  (TGT)  is outperforming the S&P 500 quarter-to-date and since May 20th.

We're also starting to see signs of life in telecom, a basket that doesn't lead until the recessionary stage of the cycle.

In June, the iShares U.S. Telecom ETF  (IYZ)  bottomed a day before the market – on the 16th. Since then, it's up 4.75%. For comparison, the S&P 500 is up 2.8% from its intraday low on June 16th.

Admittedly, one week isn't much of a trend, but investors seem to be cozying up to recession-resistant stocks.

That's certainly true of Action Alerts PLUS. In "Exiting 2 Positions, Initiating 1, and Adding to 3," Co-Portfolio Managers Bob Lang and Chris Versace announced they've sold some stocks and taken a new stake in telecom giant, Verizon  (VZ) , this week.

Lang and Versace write:

“We are funneling the proceeds into a new position in the shares of Verizon Communications with a $60 target. Adding in the current 5.1% dividend yield to be had with the shares, we are starting with a ‘one’ rating for this defensive business model and dividend-paying company.

As we'll explain in a far more detailed overview of the company that will be published for members soon after this trade alert, we see modest downside in the shares from both a fundamental and technical perspective while EPS expectations for the coming quarters have yet to be lifted for previously announced wireless price hikes some of which begin to phase in as soon as today.

As we tend to do, we are beginning with a starter position in VZ shares, and we would look to build out that position size at better prices should they present themselves.”

The Smart Play

In "Is it Game-Over for Energy Stocks" on June 14, I concluded "If the XLE closes below its 50-day moving average, make sure you're using trailing stop losses to protect your portfolio. You don't want to turn a winner into a loser. Remember, energy stocks are called "cyclicals" for a reason. At some point, the music will stop, and you won't want to be without a chair when it happens."

Indeed, the XLE broke through the 50-DMA and now, it's challenging support at the 200-DMA. Meanwhile, the S&P Oil & Gas Equipment ETF has failed the 200-DMA, suggesting selling rallies in the basket is wise. Of course, the XLE could make a stand near its 200-DMA, which may allow you to take some top stocks here for a bounce, but even more than on the 14th, these are rentals, and you need to use trailing stops for protection.

The broader commodities market could be riskier. The DBC broke below its 50-DMA yesterday, and unlike energy, which is only about 5% above its 200-DMA, the DBC would have to drop 13% before it finds its footing at the 200-DMA.

Again, if you're long commodities, protect yourself by reducing exposure and using stop losses so you don't get trapped.

As for new money, it's time to boost exposure to recessionary-stage groups, especially healthcare. The market doesn't shift from stage to stage on a dime, so there should be down days to buy. And, unlike other sectors, many stocks, particularly drugmakers, biotechs, and health insurers, are trading above the 200-DMA with revenue and profit growth. 

If picking individual stocks in defensive sectors isn't your thing, you could always use the ETFs I've mentioned for quick exposure to a large number of stocks in these groups.

Commodities' strength this year isn't surprising because they do best in the late stage of the business cycle when inflation runs hot and inflation-wrangling hasn't yet dinged demand. Toss global supply disruption due to the War in Ukraine into the mix, and the recipe for gains has been perfect.

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