Recent economic data suggests Canada has technically entered a recession. I say “technically” because while the country has recorded two consecutive quarters of declining gross domestic product (GDP), many economists have cautioned that recessions cannot be judged solely on GDP figures. Even Bank of Canada Governor Tiff Macklem has noted that labour markets, consumer spending, and other economic indicators also matter.
Still, from where many Canadians sit, the economy feels challenging. I spend a lot of time talking with investors, and many continue to struggle with the rising cost of living. Food prices remain elevated. Energy costs remain a concern. While housing rents have eased somewhat as immigration levels have moderated, wage growth has not necessarily kept pace with the cumulative impact of inflation over the past several years. That creates pressure on household budgets.
Of course, the stock market is not the economy. The TSX has remained relatively resilient this year. That said, economic weakness often takes time to work its way through corporate earnings. Investors concerned about that possibility have several options, and one of the most common is increasing exposure to defensive stocks.
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What are defensive stocks?
Defensive stocks are companies that operate in industries with relatively inelastic demand. In economics, inelastic demand simply means consumers continue buying a product or service even when economic conditions weaken. Demand may decline somewhat, but generally not by much.
Utilities are a classic example. Most people are not going to stop paying for electricity, water, or heating because the economy enters a recession. Those services remain necessities. As a result, utility companies often enjoy relatively stable revenue streams compared to more cyclical businesses.
Consumer staples offer another example. People may cut back on luxury purchases, vacations, or discretionary spending during tougher economic periods, but they still need groceries, household products, and basic personal care items. Companies operating in those industries often see less dramatic swings in demand.
Healthcare is often considered the third major defensive sector. Patients generally do not postpone necessary medications, treatments, or medical services simply because economic growth slows. That can create relatively stable demand compared to many other industries.
None of this makes defensive stocks risk-free. They are still equities and remain exposed to market risk. Share prices can fall, earnings can disappoint, and valuations can become stretched. However, compared to more cyclical sectors such as financials, real estate, or technology, defensive sectors often experience less volatility in revenues, margins, and earnings.
One way to invest in defensive stocks
Instead of trying to build a defensive portfolio stock by stock, investors may prefer a more diversified approach. One option is the BMO Low Volatility Canadian Equity ETF (TSX: ZLB).
ZLB uses a rules-based methodology to build a portfolio of lower-volatility Canadian large-cap stocks. The ETF is rebalanced every May and reconstituted every December. Rebalancing means the fund adjusts position sizes back toward its target allocations. Reconstitution means the underlying stock selection process is rerun, and companies may be added or removed from the portfolio.
If you compare ZLB’s holdings to the broader TSX, some notable differences emerge. Financials remain the largest sector allocation at just over 25%, but the ETF is more heavily tilted toward insurance companies rather than the large Canadian banks.
The second- and third-largest sector allocations are utilities and consumer staples, both at roughly 17% of the portfolio. Those sectors receive much smaller weights in the broader Canadian market, making them meaningful differentiators within ZLB.
As of June 10, ZLB offered an annualized yield of 1.9% while charging a 0.39% expense ratio. Over the past five years, ZLB generated annualized returns of 12% with dividends reinvested, before taxes.
