5 ETFs to Gain as Inflation Drops to a 2-Year Low
Inflation in the United States cooled down for the 12th consecutive month in June. The Consumer Price Index rose 3% year over year, marking the lowest rate since early 2021, and 0.2% over the last month. Although inflation has dropped from a peak of 9.1%, it is still significantly above the Federal Reserve's 2% target.
Easing inflation indicates that the economy is stabilizing and interest rates may be declining. In such an environment, some sectors tend to perform better than others. We have highlighted ETFs from those five sectors that will benefit from easing inflation. These include Technology Select Sector SPDR Fund XLK, Consumer Discretionary Select Sector SPDR Fund XLY, iShares U.S. Real Estate ETF IYR, First Trust Nasdaq Food & Beverage ETF FTXG and SPDR Gold Trust ETF GLD.
Behind the Inflation Numbers
Much of the relief came from a drop in the prices of gas, groceries and used cars. Gas prices have fallen to about $3.54 a gallon on average, nationally, down from the $5 peak last year. Grocery prices have leveled off in the past three months and were unchanged from May to June. Milk prices dropped for the third straight month and are down 1.9% from last year while egg prices have fallen 7% over the past month to $2.22 a dozen.
The price of used cars and trucks dropped by 0.5% over the month and decreased 5.2% from the same period last year. Automakers are finally producing more cars as supply shortages have abated. Airline tickets also saw a significant decline of 8.1% in June, following previous decreases in both April and May (read: 4 Top-Ranked Sector ETFs to Buy in the Second Half).
However, higher shelter costs and food prices remained causes for concern. The shelter index, which includes rent prices, advanced 7.8% year over year and accounted for about 70% of the increase in the monthly rate. But shelter cost has moved down for three straight months from 8.2% in March (highest since 1982). Food prices saw a slight increase in June, rising 0.1% during the month and 5.7% year over year.
Additionally, the cost of services, like restaurant meals, car insurance, child care and dental services, continues to rise rapidly.
The so-called core inflation, which strips out volatile components such as food and energy prices, rose 4.8% from the year-ago level and 0.2% over the past month, the smallest monthly increase in nearly two years.
Impact on Stock Market
Wall Street jumped following a cooler-than-expected inflation report, reviving hopes that the Fed was nearing the end of its interest rate increases. Per an Economic Times article, an overwhelming majority of traders continue to expect the Fed to raise the benchmark rate to the range of 5.25%-5.5% later this month. But market participants are now betting on a 26% probability that the central bank would lift short-term borrowing costs by 25 basis points in November this year, compared with a 34% probability before the data was reported.
The inflation data also indicates a stabilizing economy, which could boost investor confidence and encourage more investments in the stock market. This is because lower inflation often leads to lower interest rates, which can reduce borrowing costs for companies, potentially leading to higher profits and, in turn, higher stock prices.
Rate-sensitive mega-cap tech stocks resumed their surge, with the Nasdaq Composite Index being the outperformer. It rose 1.1%. Meanwhile, the Russell 2000 index, which houses smaller cap names, rose 0.9% to its highest since February 2023 (read: Missing the Rally in 2023? Play these ETFs).
ETFs to Buy
Technology Select Sector SPDR Fund (XLK)
Tech companies, particularly in the growth segment, are often financed with significant debt, making them sensitive to interest rates. When inflation cools and interest rates are lower or stable, these companies can borrow more cheaply to finance their growth. This can support increased profitability and higher stock prices. As such, XLK seems a prudent choice (read: Best & Worst ETF Areas of First Half 2023).
Technology Select Sector SPDR Fund targets the broad technology sector and follows the Technology Select Sector Index. It holds about 64 securities in its basket and has key holdings in software, semiconductors & semiconductor equipment, and technology hardware, storage & peripherals. Technology Select Sector SPDR Fund is the most popular and heavily-traded ETF, with AUM of $50 billion and an average daily volume of 6 million shares. The fund charges 10 bps in fees per year and has a Zacks ETF Rank #1 (Strong Buy).
Consumer Discretionary Select Sector SPDR Fund (XLY)
Lower inflation often translates into higher purchasing power for consumers, which can boost the performance of the consumer discretionary sector. These are companies that sell non-essential goods like apparel, automobiles, and entertainment. When consumers have more disposable income, they spend more on these types of goods and services. Consumer Discretionary Select Sector SPDR Fund is the largest and most popular product in this space, with AUM of $17 billion and an average daily volume of around 4.7 million shares.
It offers exposure to the broad consumer discretionary space and tracks the Consumer Discretionary Select Sector Index. Consumer Discretionary Select Sector SPDR Fund holds 53 securities in its basket, with key holdings in broadline retail, automobiles, hotels, restaurants and leisure, and specialty retail with a double-digit allocation each. It charges 0.10% in expense ratio and has a Zacks ETF Rank #1.
iShares U.S. Real Estate ETF (IYR)
While real estate can sometimes be a good hedge against inflation, the sector often benefits from low inflation because of its sensitivity to interest rates. Lower mortgage rates can stimulate demand for property and boost home prices. Furthermore, real estate investment trusts (REITs) which often carry high levels of debt, can finance their operations more cheaply in a low-interest-rate environment.
iShares U.S. Real Estate ETF offers exposure to the country’s real estate companies and REITs, which invest in real estate directly and trade like stocks. It follows the Dow Jones U.S. Real Estate Capped Index. iShares U.S. Real Estate ETF holds a basket of 78 securities with key holdings in telecom tower REITs, industrial REITs and retail REITs. It has amassed $3 billion in its asset base while trading in a heavy volume of 6 million shares a day on average. iShares U.S. Real Estate ETF charges 39 bps in annual fees and has a Zacks ETF Rank #3 (Hold).
First Trust Nasdaq Food & Beverage ETF (FTXG)
The overall food prices rose 5.7% from last year levels, meaning that food producers and retailers have been able to pass on higher costs to consumers, which is beneficial for their profitability. Additionally, if cooling inflation leads to stable or lower interest rates, it could reduce the borrowing costs for food companies, making it cheaper for them to finance their operations or invest in growth.
First Trust Nasdaq Food & Beverage ETF offers exposure to U.S. companies within the food and beverage industry. It tracks the Nasdaq US Smart Food & Beverage Index, holding 30 securities in its basket, with each accounting for less than 9% share. First Trust Nasdaq Food & Beverage ETF has AUM of $999.2 million and charges 60 bps in annual fees. It sees an average daily volume of about 119,000 shares and has a Zacks ETF Rank #3.
SPDR Gold Trust ETF (GLD)
The cooling inflation and potential pause in rate hikes could be supportive of gold. Gold is highly sensitive to rising U.S. interest rates, as these increase the opportunity cost of holding non-yielding bullion.
SPDR Gold Trust ETF tracks the price of gold bullion measured in U.S. dollars and kept in London under the custody of HSBC Bank USA. It is an ultra-popular gold ETF, with AUM of $56.5 billion and a heavy volume of about 6 million shares a day. SPDR Gold Trust ETF charges 40 bps in fees per year from investors and has a Zacks ETF Rank #3.
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SPDR Gold Shares (GLD): ETF Research Reports
Technology Select Sector SPDR ETF (XLK): ETF Research Reports
Consumer Discretionary Select Sector SPDR ETF (XLY): ETF Research Reports
iShares U.S. Real Estate ETF (IYR): ETF Research Reports
First Trust NASDAQ Food & Beverage ETF (FTXG): ETF Research Reports
