“Success consists of going from failure to failure without loss of enthusiasm”, Winston Churchill once said. Considering how the US stock market is rushing from one low to the next, it is hard not to lose your enthusiasm for investing, right?

Unless you are a contrarian investor (we’ll get back to that in a moment), there is little good news. Some of the recent headlines make you want to stick your head in the sand and disappear for a while.

- US Lender Indimac collapses
- Fannie Mae and Freddie Mac falter
- Northwest Airlines to cut 2,500 jobs

- 62,000 jobs lost, off nearly half-million for year
- Starbucks closing over 600 underperforming stores
- General Motors stock hits lowest level since 1950s
- New York Times shares tumble to a 10 year low
- Steve & Barry’s files for bankruptcy protection
- Lehman tumbles to new lows on more credit fears

With the above news and the Dow’s (Ticker: DIA) 3,000 point tumble, is it even possible to manage an ETF portfolio without losing the farm?

Yes, it is, but it takes research, an understanding of the markets (not just the US stock market) and a healthy dose of common sense. Not all asset classes (equities, fixed income, commodities, real estate) perform at the same speed. Some asset classes boom while others bust.

DIVERSIFICATION - Simple logic indicates that exposure to ALL asset classes will result in an overall smoother, lower beta performance. Tweaking the allocation (weighting) of certain asset classes can result in a portfolio that outperforms the market.

Certain US sectors deserve a higher weighting in recessionary periods.

Utilities tend to perform better (during a recession) than the overall market. In fact, on average, over the past ten years, utilities have returned over 12% from July through January. The Utilities Select Sector SPDRs (Ticker: XLU) and Vanguard’s Utility ETF (Ticker: VPU) are simple and effective ways to overweight utilities.

Health care and consumer staples also “soften the blow” of a slow economy. Even when money is tight, people still need basic food & drink, tooth paste and toilet paper. For exposure to consumer staples, look at the iShares US Consumer Goods Sector ETF (Ticker: IYK) and the Vanguard Consumer Staples ETF (Ticker: VDC).

Even though “elective procedures” such as botox and liposuction won’t be as popular, people still get sick and need treatment, regardless of the economic environment. Until we find a way to postpone a broken leg or an appendix surgery, the Rydex S&P Equal Weighted Health Care ETF (Ticker: RYH) and the Health Care Select Sector SPDRs (Ticker: XLV) could be another bright spot in your portfolio.

Times of uncertainty highlight the timeless value of gold. The SPDRs Gold Trust (Ticker: GLD) has a 3-year annualized return of 30.32% and is unlikely to fall out of favor as fears of inflation persist.

Agriculture and energy related commodities are also capsules of strengths in 2008. The iShares S&P GSCI Commodity Index Fund (Ticker: GSG) offers exposure to 24 different commodities. To get a list of all commodity ETFs (broad and narrow) go to the ETFguide database and select “commodities” under fund category.

Niche sectors like clean and alternative energy provide another avenue of diversification. The PowerShares WilderHill Clean Energy Portfolio (Ticker: PBW) was hit hard in 2008, down 33.59% even though high oil prices continue to magnify the need for alternative and clean energy. 

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The MarketVectors Global Alternative Energy ETF (Ticker: GEX) provides broad exposure while the Nuclear Energy ETF (Ticker: NLR), Claymore’s Global Solar ETF (Ticker: TAN) or First Trusts Global Wind ETF (Ticker: FAN) focus on one specific sub-sector.

No snapshot of defensive strategies would be complete without mentioning some of the many doors ProShares and Rydex open with their line-up of inverse performing ETFs. ProShares UltraShort Real Estate (Ticker: SRS) and ProShares UltraShort Financials (Ticker: SKF) were easy choices since the sub-prime mortgage debacle hit the fan in Q3 of 2007.

Just as a farmer always keeps an eye on the weather when planting, ETFguide always takes a look at the bigger picture before investing.

Unlike many Wall Street analysts who add their five-cent worth after the fact (which makes them look real smart), we implemented strategic changes to our Ready-To-Go Portfolios in Q3 of 2007. As a result, all six of our portfolios are outperforming the S&P 500 by a large margin.

True to form, Capital Defense, our most conservatively managed portfolio is outperforming in this hostile environment. We applied a number of the above mentioned defensive strategies in this portfolio (yes, we eat our own cooking) which resulted in a +8.56% YTD return, compared to a 17.26% loss for the S&P 500.

ETFguide’s Ready-To-Go Portfolios is a simple, yet sophisticated service designed to give individual investors a helping hand.

>> click here to find out more about ETFguide’s Ready-To-Go Portfolios.

Percentage gain of the Capital Defense Portfolio since inception (02-16-2006):

If you are a long-term investor, you know that diversification and asset allocation are more important (and effective) than market timing. You don’t worry (as much) about day-to day volatility.  

If you are a short-term investor or trader, you don’t worry much about asset allocation, timing is everything. It might be helpful to know that the direction of the market is most likely to change in times of extreme investor sentiment and perception. The S&P 500 tumbled 14% in less than two months. The change in investor’s sentiment should be enough to get a relief rally started but lacking the punch to knock out the bear.

More Research Articles:

Actively Managed ETFs - Will They Rock Or Roll?
The Correlation Between The Economy, Commodities And The US Dollar
The Perils Of ETF Back Testing
Finding The Right ETF Made Easy
Is Sinning Good For A Portfolio?