In a recession, how does one go about building a portfolio of exchange traded funds (ETFs)? Besides the trend lines, there are other things you can scope out to identify potential opportunities.

The typical boom-bust pattern often demonstrates that as the market turns around, the economy follows. Last week’s rally was enticing, however, there is no sure way to know that a recovery is possible or long-lasting at this point. Bradley Kay for Morningstar points out that for those of us who have cash to put back into the market, there are some criteria to look for when choosing where to go:

• Strong business, reliable cash flow. Only very profitable businesses with large moats or industries with extremely stable revenues will make it through the slump while staying in the black.
• Low leverage and low exposure to financials. The credit crunch is not going to go away or solve itself. A couple of bad quarters and debt coming due could drive even very solid businesses with too much leverage into bankruptcy, and there is no better way to permanently impair the value of equity than for debt holders to seize it all.
• Broad diversification. Is there any more to say? Find those funds that are more diversified.
• Large discount to fair market value. There should be decent to considerable price appreciation involved if you get into the market at this time, right?

Of 840 ETFs on the market, Morningstar staffers found the Vanguard Dividend Appreciation (VIG) to be the winner. This fund has an average dividend yield lower than the S&P 500, but the security of its yield and quality of its holdings are unmatched. Some of the stronger companies included, among others, Coca-Cola (KO), Procter & Gamble (PG) and Wal-Mart (WMT). These companies provide some of the products that consumers are still buying – recession or not.

While these points can be taken under advisement, watch the trend lines to see where the opportunities are.

Tags: Dividend ETFs, ETF 101, S&P 500, Sector ETFs, Trend Following, VIG