VTI - CPI Continues To Chill: Small Caps Eyeing Critical Support On VIOO Chart

2023-03-14 09:45:01 ET

Summary

• The February CPI report came in near economists' expectations, and stocks held their premarket gains.
• Bond yields have ticked higher this morning as the flight to safety trade has pulled back.
• The focus remains on the regional banking crisis and what the Fed will do next.
• Small cap stocks hang above critical support and I note one key resistance level to monitor.

The February CPI rate verified at expectations of +0.4%. The core rate came in at 0.5%, 0.1% hotter than expectations. The year-on-year rates were 6.0% on headline, down from the 6.4% mark in January, while the ex-food and energy rate was +5.5%, about in line with economists' expectations.

It was the 8th consecutive monthly drop in the annual rate of inflation and the weakest reading since September 2021. Core CPI is now at the softest level since November 2021. Importantly, core CPI ex-shelter verified at +0.43% from January and +6.14% from a year ago, the 5th straight monthly decline in the YoY rate.

February CPI Report: Close to Expectations

Yet Another Monthly Drop in the MoM Headline Rate

Rates dropped slightly following the inflation data hitting the tape while stock market futures rose modestly. Traders were focused mainly on the year-on-year core rate of 5.5% which was an improvement from prior months. Overall, the data was very close to the forecast.

The macro focus remains on the banking sector following the SVB Financial Group ( SIVB ) collapse over the weekend and the Signature Bank ( SBNY ) regulatory takeover shortly after. The new BTFP term lending facility is in place to backstop depositors. This morning's inflation report is thus somewhat of an afterthought considering that the small and medium-sized banking crisis began after the CPI survey was conducted.

Within the report, there was some relief in used car prices while shelter prices were once again the primary driver of the month-over-month consumer price rise.

Shelter Prices Keep Driving CPI

Airfares Rise Most in February, Used Vehicle Price Relief

Going into the inflation print today, the anticipated S&P 500 (SP500) change priced by the options market was 1.5% while the previous set of reports led to an average (SPX) price change of 1.8%, so volatility is typically high on CPI days. Today will likely be no different, but perhaps due more in part to the banking sector and what shoe could drop next.

Large Realized Moves on CPI Day, Big Implied Change Today

Putting it all together, there is now a more than 88% chance of a small 25 basis point rate hike at next week's FOMC meeting and about a one in nine chance of no change at all - a sharp contrast to what was seen a week ago when there was a high 70% probability of a half-point policy rate increase.

Rate Hikes All Done? It's Possible.

The SIVB closure and freefall in regional bank stocks have hurt small-cap indexes much more than large-cap indices. Also, inflation can often impact small firms more than large corporations. Just in the last few weeks, the small-cap index has plunged 14% peak to trough.

According to the issuer , the Vanguard S&P Small-Cap 600 ETF (VIOO) tracks an index representing the S&P Small-Cap 600, which is the 600 smallest firms in the S&P 1000 index. The fund carries a modest 0.10% annual expense ratio and pays a small 1.4% dividend yield. With 25-day average volume of under 100,000 shares, trading is rather light, and the exchange-traded fund's ("ETF's") median 30-day bid/ask spread can be material with the average being 10 basis points.

With a median market cap of just $2.2 billion and earnings growth near 14%, the fund's 12.1 price-to-earnings ratio as of January 31, 2023, appears favorable. Moreover, recent downside price action perhaps makes VIOO even cheaper. Sector-wise, a high allocation to the Financials sector makes the ETF move based on where rates are headed.

In general, small caps can do better during inflationary environments due to their more value-oriented allocation compared to the growth-heavy S&P 500 large-cap index. Together, Information Technology, Communication Services, and Consumer Discretionary make up less than 30% of VIOO's portfolio compared to more than 40% in the SPX.

Small Cap Sector Weights: Heavy In Financials, Light in TMT

The Technical Take

With a low valuation and value-oriented construct, how does the chart look? I see key support at the pre-COVID highs and 2022 lows not far from the latest close in the $160 to $165 range. Also critical to hold is the late 2022 trough near $170. That's critical since VIOO has been putting in higher highs and higher lows since October, and it is crucial for the bulls to keep that uptrend going.

Notice in the chart below that VIOO notched its most oversold reading since March 2020, so a bounce may be due here, but the bulls have a lot of work to do in order to get the fund back to a test of obvious resistance just shy of $200. I'm a buy on VIOO with a stop under the October low. Momentum traders can also play it via a breakout above $200.

VIOO: $170 First Support, $198 Resistance

The Bottom Line

The CPI report will be cast aside quite quickly. With numbers that came in near expectations and data that is now arguably stale given the disinflationary nature of the regional banking crisis, traders' eyes will refocus on the health of the Financials sector and what the Fed will do and say next week.

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