Canada's economic pulse is weakening, with the latest data hinting at a potential recession on the horizon.

Statistics Canada's recent figures indicate that the nation's Gross Domestic Product (GDP) stalled in August and based on early estimates, contracted slightly in the third quarter.

This follows a period of flat growth and suggests that the economy may be cooling under the pressure of persistent high interest rates intended to lower inflation.

The Bank of Canada has paused interest rate hikes at 5% recently, and with their forecast projecting subdued economic growth into next year, caution is becoming a theme.

With two consecutive months without growth, the term 'technical recession' — typically marked by back-to-back quarters of negative growth — is starting to surface. Nonetheless, experts usually seek signs of a widespread downturn before declaring a full-blown recession.

For long-term investors like me, drastic portfolio changes are not typically the move; however, for those with a strategy that favors sector rotation or a lower-risk approach, adjusting holdings could be a prudent step.

As we brace for a possible economic downturn, certain defensive ETFs deserve attention, potentially offering a buffer against the market's rougher tides. Here are ETFs to consider.

Low-volatility Canadian equity ETFs

Low-volatility Canadian equity ETFs are built on a simple yet powerful premise: by selecting stocks that historically show less price movement, the ETF aims to offer a smoother investment ride.

These ETFs typically employ a rules-based strategy to pick stocks with the lowest volatility, measured by standard deviation and beta, over a specific timeframe, and then weight them inversely to their volatility.

To break it down, standard deviation is a statistical measurement that signifies the range of a stock's historical price fluctuations. A lower standard deviation means the stock’s price doesn’t swing wildly, but rather moves within a narrower band.

Beta, on the other hand, measures a stock's movement relative to the overall market. A beta less than 1 suggests the stock is less volatile than the market; if the market dips or surges, the stock is likely to move less in comparison.

These metrics are important because they help identify stocks that are less likely to experience extreme ups and downs, which can be particularly appealing during uncertain or turbulent market conditions.

Investors who are risk-averse or nearing retirement might find low-volatility ETFs especially attractive, as they aim to protect against the stomach-churning peaks and valleys that can occur in more volatile portfolios, without needing to reduce an equity allocation.

In Canada, low-volatility ETFs often skew towards defensive sectors like consumer staples and utilities. These sectors are considered defensive because they consist of companies that provide essential services or goods that consumers need regardless of economic conditions.

For instance, regardless of whether the economy is booming or struggling, people still need to heat their homes (utilities) and buy groceries (consumer staples). This consistent demand typically translates to more stable revenue streams for these companies, making their stocks less sensitive to market cycles.

Low-volatility ETFs to watch include the BMO Low Volatility Canadian Equity ETF (ZLB) and the CIBC Qx Canadian Low Volatility Dividend ETF (CQLC), the latter of which is listed on Cboe Canada.

For a deep dive into how CQLC and its international and U.S. counterparts work, consider this analysis of CIBC's low volatility ETF lineup a read here.  

Defensive Canadian sector equity ETFs

DIY investors keen on crafting a portfolio resilient to market downturns might consider an approach that involves overweighting defensive sectors.

In the Canadian market, the heavyweight sectors tend to be financials and energy stocks, which are heavily represented in market-cap-weighted indices.

However, these sectors are considered defensive because their fortunes are closely tied to economic cycles; they are cyclical, with their performance often ebbing and flowing with economic conditions.

In contrast, utilities and consumer staples typically have a much smaller presence in broad market indices. These sectors are more defensive in nature; as mentioned earlier, companies within them provide essential services and products that remain in demand, recession or not.

Therefore, to increase the defensive stance of a portfolio, sector-specific Canadian equity funds focusing on these areas can be quite strategic.

Investors have a choice in how they approach these sector indices: market-cap weighted or equal weight. A market-cap-weighted strategy might appear to be more reflective of the market, but it can lead to significant concentration risk.

For instance, in a relatively small sector like consumer staples, a market-cap weighted ETF like the iShares S&P/TSX Capped Consumer Staples Index ETF (XST) has a single company like Alimentation Couche Tard representing over a quarter of the ETF's value.

This exposes investors to idiosyncratic risk, where the performance of the ETF could be overly dependent on the fortunes of one or two large players.

An equal-weight approach mitigates this risk by allocating the same percentage to each stock within the ETF, regardless of the company's size. While this can mean giving more weight to smaller companies than they have in the market, it also means that the ETF's performance is less tied to any single stock.

This strategy can offer a more balanced and potentially less volatile experience, which may be preferable for those specifically seeking defensive positions in their portfolios. A great example of this is the BMO Equal Weight Utilities Index ETF (ZUT).

Please note this article is for information purposes only and does not in any way constitute investment advice. It is essential that you seek advice from a registered financial professional prior to making any investment decision.