ETFs
Inflation slows in June, prompting a surge in lagging ETFs
U.S. inflation slowed in June for the third consecutive month. The consumer price index rose just 3% year-on-year last month, compared with 3.3% annual growth in May. On a monthly basis, the index fell 0.1% from May’s stagnation. This was the first monthly decline in inflation since 2020 and the smallest annual price increase since March 2021.
So-called core inflation, which excludes volatile components such as food and energy prices, rose by just 0.1% from the previous month, the lowest monthly core figure since August 2021, and by 3.3% from the previous month. Both figures are down from May’s figures, which showed monthly growth of 0.2% and annual growth of 3.4%.
Following the encouraging inflation data, markets priced in about an 89% chance that the Fed will start cutting rates at its September meeting, up from 75% the day before, according to CME Group data. That boosted market confidence that the Fed would start cutting interest rates in September, leading to a sector rotation from the booming tech sector to lagging sectors that could benefit from lower rates, such as industrials and small caps.
In particular, the Russell 2000, a small-cap stock that has seen a sharp slowdown this year, jumped 3.4%, hitting its highest level in more than three months. The S&P 500 housing index jumped 2.8%, paring its year-to-date losses to 1%. For example, ETFs in some struggling segments of the market saw smooth trading after the inflation data. These included iShares U.S. Residential Construction Exchange Traded Fund (BAT: ITB), Invesco WilderHill Clean Energy ETF (NYSE:PBW), ETF Virtus LifeSci Biotech Clinical Trials (NYSE: BBC), iShares Micro-Cap ETFs (NYSE:IWC) and SPDR S&P Regional Banks Exchange Traded Fund (NYSE: KRE).
Why sector rotation?
Small-cap stocks have surged on expectations that lower interest rates will improve the lives of these companies. This is especially true since lower interest rates will lead to lower borrowing costs, which will help companies expand their businesses more easily, leading to higher profitability. Many small and mid-sized companies have higher floating debt than their larger counterparts.
High dividend-yielding sectors, such as utilities and real estate, will be the main beneficiaries of rate cuts, given their sensitivity to interest rates. This is especially true since these sectors offer higher yields due to their exceptional yields. In real estate, lower rates can stimulate housing market activity by making mortgages more affordable. In addition, stocks in capital-intensive sectors, such as telecommunications, will also benefit from lower rates. Corporates will also face lower interest rates over time.
Lower rates will also have a positive impact on financials and consumer discretionary. Lower borrowing costs may lead to increased consumer spending in consumer discretionary sectors. In the financial sector, while lower rates may squeeze banks’ net interest margins, they may also encourage lending and potentially lead to increased lending activity to consumers and businesses.
Focus on ETFs
iShares US Home Construction ETF – Up 6.2%
The iShares US Home Construction ETF provides exposure to U.S. companies that manufacture residential homes by tracking the Dow Jones US Select Home Construction Index.
With $2.5 billion in assets under management, the iShares US Home Construction ETF holds a basket of 44 stocks, with a heavy concentration on the two largest companies. The product charges 40 bps in annual fees and trades in a large volume of about 2 million shares per day, on average. The iShares US Home Construction ETF has a Zacks ETF Rank #3 (Hold) with a high risk outlook.
Invesco WilderHill Clean Energy ETF – Up 5.8%
The Invesco WilderHill Clean Energy ETF provides exposure to U.S.-listed companies committed to cleaner energy and conservation. It tracks the WilderHill Clean Energy Index and holds 71 stocks in its basket.
The Invesco WilderHill Clean Energy ETF has accumulated $296.2 million in assets and trades at a healthy volume of about 383,000 shares per day. It charges investors 66 bps in fees per year.
Virtus LifeSci Biotech Clinical Trials ETF – Up 5.4%
The Virtus LifeSci Biotech Clinical Trials ETF provides exposure to companies with promising drugs in human clinical trials but that have not yet been approved by the FDA or put into production. It tracks the LifeSci Biotechnology Clinical Trials Index and holds 104 stocks in its basket, with none representing more than 2.9% of the shares.
The Virtus LifeSci Biotech Clinical Trials ETF has accumulated $10.5 million in assets and charges 79 bps in fees per year to its investors. It trades an average of 4,000 shares per day and is rated a Zacks ETF Rank #2 (Buy) with a high risk outlook.
iShares Micro-Cap ETF – Up 4.9%
The iShares Micro-Cap ETF provides exposure to very small U.S. public companies by tracking the Russell Microcap Index. It holds a broad basket of 1,476 stocks, each representing no more than 0.5% of assets. IWC has key holdings in the healthcare, financials, industrials, and information technology sectors, with double-digit exposure in each.
The iShares Micro-Cap ETF has accumulated $788.3 million in assets and trades an average of 27,000 shares per day. It is ranked #3 by Zacks ETF with a high risk outlook.
SPDR S&P Regional Banking ETF – Up 4.2%
The SPDR S&P Regional Banking ETF provides exposure to the regional banking segment by tracking the S&P Regional Banks Select Industry Index. It holds 141 stocks in its basket, each representing a maximum of 2.4% of assets.
The SPDR S&P Regional Banking ETF has $2.4 billion in assets under management and charges 35 bps in annual fees. It trades on an average daily volume of 12 million shares and carries a Zacks Rank #4 (Sell) with a high risk outlook.
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