If a Stock Market Correction Is Coming, This 1 ETF Could Be the Smartest Buy Right Now

The S&P 500's Shiller CAPE ratio, which measures the index's current price relative to inflation-adjusted earnings over the past 10 years, just hit 42. The last time it rose that high, the tech collapse in 2000 soon followed.

While strong corporate earnings growth is supporting the market here, stocks could take a hit if the narrative changes. Inflation is well above the Federal Reserve's target. GDP growth has slowed substantially over the past two quarters. President Donald Trump is trying to restart his tariff strategy. Any or all of these factors could be the catalyst to send stock prices sharply lower. With the S&P 500 nearly as expensive as it has ever been, according to the Shiller CAPE ratio, there's little room for error.

There are ways, however, to protect your portfolio. By pivoting to more defensive equities, investors can mitigate downside risk and maybe even generate a little extra income on the side. That's why the Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD) becomes really attractive during a correction. Its robust selection strategy produces a portfolio of durable, quality companies with strong dividend yields.

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Why SCHD works well in a correction

When the S&P 500 turns lower, investors often become risk-averse in a hurry. In the case of equity investors, they may do a 180-degree pivot on their strategy and push entirely into bonds or cash. People who tilt their portfolios more defensively usually target well-established stocks or exchange-traded funds (ETFs) that generate lots of cash and are economically resilient.

Those are the kinds of stocks that the Schwab U.S. Dividend Equity ETF targets. It uses several fundamental measures to ensure the companies it invests in maintain balance sheet health. It looks for long histories of dividend payments to provide an important source of income. And it looks for above-average yields, so investors have a stronger offset to potential share price declines.

Using these criteria, the fund builds a portfolio of roughly 100 stocks that demonstrate the best combination of all the factors. Its 3.3% dividend yield is very appealing, but so is the high-quality standing of the companies in the portfolio.

Those kinds of stocks tend to hold up better in tougher market environments.

SCHD did very well in 2022

The bear market of 2022 is a great example of why high-quality dividend stocks are so important in portfolios.

The S&P 500 finished the year down 18% as the Fed's aggressive rate-hiking cycle hurt both stocks and bonds. The Schwab U.S. Dividend Equity ETF, however, lost only 3% by year-end. It was one of the best calendar years of outperformance since the fund's 2011 launch. Its high dividend yield also provided an important source of income, enhancing total returns during this difficult period.

The Schwab U.S. Dividend Equity ETF might not be exciting. It doesn't hold many tech, semiconductor, or AI stocks. But its focus on durability, quality, and yield usually comes in handy when investors need it the most.

David Dierking has positions in Schwab U.S. Dividend Equity ETF. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.