If a Recession Is Coming, This Dividend ETF Could Be the Smartest Long-Term Buy Right Now

Depending on the source, odds of a recession are either in line with the historical average of 15% or running as high as 40%, the latter of which is obviously concerning.

Compounding those worries is the fact that the Federal Reserve raised interest rates last week, and there's rising belief that one more rate hike is coming before the end of this year. The Fed aims to quash inflation, but some experts believe that developments in the bond market suggest the risk of a recession in the coming months cannot be overlooked.

Recession or not, there's a lot to like with this dividend ETF. Image source: Getty Images.

None of us possesses a crystal ball, so recession forecasting can be a hazardous occupation. Recession preparation is what investors should focus on, and it can be achieved with dividend stocks and exchange-traded funds (ETFs) such as the State Street SPDR S&P Dividend ETF (NYSEMKT: SDY). Although the name doesn't say it outright, this ETF may be top-notch at buffering recessions.

An aristocrat approach

Many equity income investors are familiar with the Dividend Aristocrats® (the term Dividend Aristocrats® is a registered trademark of Standard & Poor's Financial Services LLC), those members of the S&P 500 that have boosted payouts for at least 25 consecutive years.

Think of this SPDR ETF as the high-dividend answer to a standard Dividend Aristocrats® offering. This ETF tracks the S&P High Yield Dividend Aristocrats® index, which is a collection of S&P Composite 1500 members with dividend-increase streaks of at least 25 years.

Investors who are keen on the traditional Dividend Aristocrats don't need to worry about being "cheated" with this nearly $21 billion SPDR ETF, as 68 of its 155 holdings are members of the S&P 500 Dividend Aristocrats® index. In fact, many members of this ETF's roster have payout-increase streaks spanning three or four decades. Some even meet Dividend King criteria, defined as companies with at least 50 straight years of increased payouts.

The point is that this ETF could be a solid choice before or during economic contractions because its holdings have already proven they will raise dividends during prosperous periods and, more importantly, during recessions.

Playing offense with defense

When it comes to investing, there are instances when addition by subtraction helps. Said differently, what market participants avoid during rough economic patches is almost as important as what they include in their portfolios.

Historically vulnerable sectors during recessions include consumer discretionary (as consumers dial back nonessential spending) and financial services (as credit defaults rise). Those groups combine for just 18.7% of the SPDR ETF's weight. Energy and real estate, another pair of sectors that often lag during recessions, combine for less than 8% of this ETF's roster.

Good news: This dividend ETF devotes more than 37% of its portfolio to defensive consumer staples, utilities, and healthcare stocks, which are among the best-performing groups when the economy is on the rocks. Clearly, avoiding a recession is the preferred option, but in a worst-case economic scenario, this SPDR ETF may be a best-case solution for dividend investors.

Todd Shriber has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.