VTI - Rising Energy Prices Boost CPI Invesco S&P SmallCap Energy ETF In Focus

2023-09-13 10:05:24 ET

Summary

• August CPI report showed a 0.6% rise in monthly headline inflation, matching expectations.
• Core inflation rose 0.3%, slightly higher than forecasts.
• Energy prices contributed sharply to the rise in headline inflation, with a 5.6% increase in August.
• I outline key price levels to watch on small-cap Energy equities via the PSCE ETF, which has surged from their Q2 lows.

The August CPI report revealed a 0.6% rise in monthly headline inflation, the fastest rate since June 2022, matching what economists were expecting. The core rate, which strips out volatile food and energy costs, rose 0.3%, a tick hotter than the consensus forecast.

On a year-over-year basis, headline CPI is now at +3.7%, also slightly above expectations, while core inflation is +4.3% - the lowest annual increase since September 2021. The non-seasonally adjusted CPI value of 307.02 came in barely above the 306.98 forecast, but stocks managed to rally from their premarket lows in the minutes after the report’s release while Treasury rates initially jumped.

On a 3-month annualized basis, the core CPI rate has now dropped to just 2.4%. The so-called “super core” CPI (core services less housing) confirmed a re-acceleration with its 0.4% monthly increase, up from just +0.2% in July.

As excess savings from the pandemic appear just about depleted, workers are now benefitting from rising real wages. Real average hourly earnings are higher by 0.5% from 12 months ago while real weekly earnings are positive by three-tenths of a percentage point.

Overall, the report was not all that shocking to Wall Street traders and Fed-watchers – the CME FedWatch Tool still shows a modest 5% chance of a rate hike at the FOMC’s September 20 meeting. Keep your eye on tomorrow’s PPI report and August Advance Retail Sales to be issued later this week to see if that expectation shifts.

Headline CPI Rises As Energy Prices Jump in August

Easing Core CPI Rate Across Timeframes

Supercore CPI Contributors

2.4% Three-Month Annualized CPI

Small Chance (5%) of a Rate Hike Next Week

After a second straight month of a higher year-on-year CPI rate, oil prices are in focus. A rise in energy costs pressured headline inflation, and with WTI crude oil now nearing $90 per barrel, there’s the risk that both businesses and consumers may encounter even higher expenses. But will oil find some sellers at this lofty level? Consider that we have not seen $90+ WTI since November of last year.

Energy CPI +5.6% in August, Fueled By Rising Oil

Today, I am issuing a buy rating on the Invesco S&P SmallCap Energy ETF (PSCE). I assert that its valuation is attractive and technical momentum is strong.

According to the issuer , PSCE is based on the S&P SmallCap 600 Capped Energy Index. The fund will normally invest at least 90% of its total assets in the securities of small-capitalization US energy companies that comprise the underlying index. These companies are engaged in the business of producing, distributing, or servicing energy-related products, including oil and gas exploration and production, refining, oil services and pipelines. The index is a subset of the S&P SmallCap 600 Index, which is a float-adjusted, market-cap-weighted index reflecting the U.S. small-cap market.

With its inception in 2010, PSCE is not a large fund with its total assets under management of just $263 million while its annual expense ratio is modest at 0.29%. With a trailing 12-month dividend yield above the S&P 500’s 1.6% rate (2.2%), this small-cap fund actually offers a decent income return. What’s more, its forward price-to-earnings ratio is very attractive at just 7.3x as of June 30, 2023, per Invesco. Liquidity can be lukewarm at times given its 0.09% 30-day median bid/ask spread and typical trading volume of less than 40,000 shares daily, so using limit orders when trading PSCE is prudent.

What’s impressive, though, is that even as inflation appears to still be trending lower, higher oil and gasoline prices are undoubtedly helping the Energy sector. PSCE sports an A+ momentum rating from Seeking Alpha on this ETF which has a median market cap size of $2.5 billion. The fund is 100% US and most of the stocks are from two industries: Oil & Gas Exploration & Production (40%) and Oil & Gas Equipment & Services (24%). It is also a concentrated 30-stock portfolio with 63% of the ETF’s assets in the top 10 holdings, so that's a key risk.

PSCE: Geographic & Industry Breakdowns

PSCE: Portfolio & Factor Profiles

The Technical Take

With a dirt-cheap valuation and market-leading momentum, PSCE sports a favorable chart. Notice in the graph below that shares recently broke out from a symmetrical triangle pattern. With a height of about $24, this formation implies a measured move price objective to $77 based on the breakout point in the low $50s. That would be a significant 30% increase from the current share price.

Bigger picture, PSCE sports a bullish RSI momentum range while the 200-day moving average should turn upward sloping before long given the strong nearly 50% advance off its late Q2 nadir in the $41 to $42 range. Moreover, following a golden cross pattern last month, it’s becoming clear that the bulls are in control. With light overhead supply from recent years up to the $70s, I see more upside to come, but would like to see the low $50s breakout point hold if we do get a late September swoon.

PSCE: Bullish Breakout Targets the Mid-$70s

The Bottom Line

This morning’s generally in-line CPI report underscores the importance of energy price trends for future inflation rates. With the Fed unlikely to raise rates next week, investors can focus on what’s working, and there are few spots better than small-cap energy shares.

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