Inflation in the United States cooled down in June for the third consecutive month. The Consumer Price Index rose just 3% year over year last month, down from an annual growth of 3.3% in May. On a monthly basis, the index declined 0.1% from May’s flat reading. This marked the first monthly drop in inflation since 2020 and the slowest annual price gain since March 2021.
The so-called core inflation, which strips out volatile components such as food and energy prices, rose only 0.1% over the prior month, the lowest monthly core reading since August 2021, and 3.3% from the year-ago month. Both numbers are down from May’s reading of 0.2% monthly growth and 3.4% annual growth.
Following the encouraging inflation data, markets priced in a roughly 89% chance that the Fed will begin to cut rates at its September meeting, up from 75% a day prior, according to data from the CME Group. This has deepened the market’s confidence that the Fed would begin cutting interest rates in September, leading to a sector rotation from the hot technology sector to the laggards that could benefit from falling rates like industrials and small caps.
In particular, the small-cap Russell 2000, which has significantly lagged this year, jumped 3.4% to a more than three-month high. The S&P 500 real Estate index jumped 2.8%, trimming its year-to-date losses to 1%. As such, ETFs from some beaten-down corners of the market saw smooth trading following the inflation data. These include iShares U.S. Home Construction ETF (BATS:ITB), Invesco WilderHill Clean Energy ETF (NYSE:PBW), Virtus LifeSci Biotech Clinical Trials ETF (NYSE:BBC), iShares Micro-Cap ETF (NYSE:IWC) and SPDR S&P Regional Banking ETF (NYSE:KRE).
Why Sector Rotation?
Small-cap stocks surged amid expectations that rate cuts would improve conditions for these companies. This is especially true as lower rates will lead to reduced borrowing costs, which help businesses expand their operations more easily, resulting in increased profitability. Many small and mid-caps companies have more floating debt than their larger counterparts.
High-dividend-yield sectors such as utilities and real estate will be the biggest beneficiaries of the rate cuts, given their sensitivity to interest rates. This is especially true as these offer higher returns due to their outsized yields. In real estate, lower rates can boost housing market activity by making mortgages more affordable. Additionally, securities in capital-intensive sectors like telecom will also benefit from lower rates. Businesses will also face lower loan rates over time.
Lower rates will also have a positive impact on consumer discretionary and financial services. Reduced borrowing costs can lead to increased consumer spending for consumer discretionary sectors. In the financial sector, while lower rates can compress net interest margins for banks, they can also encourage lending and potentially lead to increased consumer and business loan activity.
ETFs in Focus
iShares U.S. Home Construction ETF – Up 6.2%
iShares U.S. Home Construction ETF provides exposure to U.S. companies that manufacture residential homes by tracking the Dow Jones U.S. Select Home Construction Index.
With an AUM of $2.5 billion, iShares U.S. Home Construction ETF holds a basket of 44 stocks, with a heavy concentration on the top two firms. The product charges 40 bps in annual fees and trades in a heavy volume of around 2 million shares a day, on average. iShares U.S. Home Construction ETF has a Zacks ETF Rank #3 (Hold) with a High risk outlook.
Invesco WilderHill Clean Energy ETF – Up 5.8%
Invesco WilderHill Clean Energy ETF offers exposure to companies that are publicly traded in the United States and engaged in the business of advancement of cleaner energy and conservation. It follows the WilderHill Clean Energy Index and holds 71 stocks in its basket.
Invesco WilderHill Clean Energy ETF has amassed $296.2 million in its asset base and trades in a solid volume of around 383,000 shares a day. It charges investors 66 bps in fees per year.
Virtus LifeSci Biotech Clinical Trials ETF – Up 5.4%
Virtus LifeSci Biotech Clinical Trials ETF offers exposure to companies with promising drugs in clinical human trials that have not yet been approved by the FDA or gone into production. It follows the LifeSci Biotechnology Clinical Trials Index and holds 104 securities in its basket, with none accounting for more than 2.9% share.
Virtus LifeSci Biotech Clinical Trials ETF amassed $10.5 million in its asset base and charges 79 bps in fees per year from its investors. It trades in an average daily volume of 4,000 shares and carries a Zacks ETF Rank #2 (Buy) with a High risk outlook.
iShares Micro-Cap ETF – Up 4.9%
iShares Micro-Cap ETF offers exposure to very small public U.S. companies by tracking the Russell Microcap Index. It holds a large basket of 1,476 stocks with each accounting for no more than 0.5% of assets. IWC has key holdings in healthcare, financials, industrials and information technology with double-digit exposure each.
iShares Micro-Cap ETF has amassed $788.3 million in its asset base and trades in a volume of 27,000 shares a day on average. It has a Zacks ETF Rank #3 with a High risk outlook.
SPDR S&P Regional Banking ETF – Up 4.2%
SPDR S&P Regional Banking ETF provides exposure to the regional banks segment by tracking the S&P Regional Banks Select Industry Index. It holds 141 stocks in its basket, with each accounting for no more than 2.4% of the assets.
SPDR S&P Regional Banking ETF has AUM of $2.4 billion and charges 35 bps in annual fees. It trades in an average daily volume of 12 million shares and has a Zacks Rank #4 (Sell) with a High risk outlook.
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