When taken at first glance, the July CPI report, with so-called headline inflation dropping to 3.2%, might be taken by investors as a major step toward all the things market bulls want.
They want the Fed to stop raising rates and begin lowering them. They want inflation contained, cut and vanquished, rather than exploding beyond what have been the highest CPI readings in about three decades.
And they want U.S. Treasury bond rates to drop, particularly the rate on the 10-year bond, so that consumer credit, like mortgages, car and credit card loans, can return to the easy money we had before the Fed raised rates 11 times starting in 2020.
Market optimists want all of this, and they want it now. That brings up a classic good news-/bad news situation. The CPI report released Thursday morning was modestly encouraging.
CPI and the Flexibility of ETFs
But it’s likely not a game-changer for investors, unless they take advantage of the hyperflexibility and targeting ability offered by ETFs. More on that in a moment.
The CPI report showed that inflation has been up 3.2% over the past 12 months. That’s a very hopeful figure, versus figures twice that or higher not long ago. Meanwhile, when you put the volatile food and energy parts of the CPI calculation back in, the latest figure was 4.7%, still a decent number for those who hope the bull market keepsgoing.
There are two potential flies in that ointment. One is that investors and consumers need to realize prices of the goods and services they buy are not going down. They are still rising, but at a slower rate than in the recent past. This is “disinflation,” not “deflation.”
CPI rates in the 3%-5% range are well above what U.S. consumers are used to. That, along with the fact that rate hikes haven’t yet impacted consumers fully, should moderate the enthusiasm. That’s probably one reason the S&P 500 jumped initially on Thursday, only to quickly give back most of the gains.
The second fly is that energy—excluded from the core inflation rate—is about to jump. In fact, it is already happening, with the price of WTI Crude oil up from under $68 a barrel near the end of June, to north of $83 today.
That not only caused that full version of CPI (that includes energy and food) to rise, but it also represents an enticing opportunity for those investors who are more sanguine about the current stock market and looking for a bright spot. Energy ETFs might be that bright spot during the next quarter or two.
Energy ETFs and the CPI
The beauty of ETFs is that they allow us to break the stock market down into a seemingly endless number of pieces. That allows for a nice combination. You can target a certain area, but not have the “blowup” risk of a single stock. Targeting and diversification meet to provide a very flexible tool.
This is especially the case when looking at the energy sector. For instance, the ProShares K-1 Free Crude Oil Strategy ETF (OILK) aims to track the price of WTI Crude Oil (that’s oil pumped and processed in the U.S., as opposed to elsewhere). The ETF is clearly in the “ignored” category, with only $102 million in assets, which likely has a lot to do with the fact that the energy sector has taken a true back seat to tech and other growth stocks for a while. OILK’s asset flows have started to pick up in recent days.
Oil stocks are a popular spot for ETF investors when the price of “black gold” starts to bubble up. The Energy Select Sector SPDR Fund (XLE) filters down the energy stocks within the S&P 500 index, then weights them by market capitalization. It’s up just over 3% so far in 2023. It tends to cluster around a small number of giant U.S.-based energy conglomerates.
The tends to be much more volatile than XLE, since oil exploration is riskier than other aspects of the energy business, but also can bring higher returns. XOP is a $3.8 billion ETF that currently owns 62 stocks, with none accounting for as much as 3% of assets. XOP’s total return over the past five years is essentially zero.
Inflation is a bigger part of investors’ and consumers’ lives than it has been in over a decade. This changes the game when it comes to where to hunt for value and growth. After being the proverbial red-headed stepchild for a while, perhaps the energy sector, at a time of surging oil prices, can be an oasis for weary, and wary, ETFs investors.
