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Inflation in the United States broadly slowed in October, indicating that the Fed is done hiking interest rates and could potentially start cutting them next year. The Consumer Price Index rose 3.2% year over year in October, after an annual rise of 3.7% both in September and August and down from the market expectation of about 3.3%. Inflation has now fallen significantly from a 40-year high of 9.1% in June 2022.

The so-called core inflation, which strips out volatile components such as food and energy prices, rose 4% year over year — the slowest annual pace since September 2021 — according to the latest data from the Bureau of Labor Statistics.

With easing inflation, some sectors tend to perform better than others. We have highlighted ETFs from five sectors that will benefit the most from the slowdown in inflation. These include Technology Select Sector SPDR Fund (XLK - Free Report), Consumer Discretionary Select Sector SPDR Fund (XLY - Free Report), iShares U.S. Home Construction ETF (ITB - Free Report), SPDR Gold Trust ETF (GLD - Free Report) and iShares Russell 2000 ETF (IWM - Free Report).

Behind the Inflation Numbers

Much of the relief came from a drop in the prices of energy, airline fares and used cars. Overall, energy prices declined 4.5% from the year-ago month, with gasoline prices declining 5.3%. Airfares and used cars dropped 13.2% and 7.1% year over year, respectively.  

Though shelter was the biggest factor in the monthly increase in core inflation, rising 0.3%, it was still lower than September's 0.6% monthly jump. The shelter index, which accounts for two-thirds of the inflation index, increased 6.7% from a year ago. Meanwhile, food prices climbed 3.3% from the year-ago month. The index for food at home increased 0.3% over the month after rising just 0.1% in September.

Additionally, the cost of services, like restaurant meals, car insurance, child care and dental services, rose 5.1% year over year.

Following the softer inflation data, the odds of a rate hike at the Fed’s December meeting dropped from 14% to 0%, according to the CME FedWatch Tool.

ETFs to Gain

Consumer Discretionary Select Sector SPDR Fund (XLY)

Lower inflation often translates into higher purchasing power for consumers, thus boosting the performance of the consumer discretionary sector. The companies 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 $16.5 billion and an average daily volume of around 6 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, hotels, restaurants and leisure, automobiles, and specialty retail with a double-digit allocation each. It charges 0.10% in expense ratio and has a Zacks ETF Rank #1 (Strong 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 the Fed stops hiking rates, 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.

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, technology hardware, storage & peripherals, and semiconductors & semiconductor equipment. Technology Select Sector SPDR Fund is the most popular and heavily traded ETF, with AUM of $52.5 billion and an average daily volume of 6.5 million shares. The fund charges 10 bps in fees per year and has a Zacks ETF Rank #1.

iShares U.S. Home Construction ETF (ITB)

Homebuilder ETF will get a dual advantage from easing inflation and a higher shelter cost. 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 billion, it holds a basket of 46 stocks, with a heavy concentration on the top two firms. iShares U.S. Home Construction ETF charges 40 bps in annual fees and trades in a heavy volume of around 3.5 million shares a day on average. iShares U.S. Home Construction ETF has a Zacks ETF Rank #3 (Hold).

SPDR Gold Trust ETF (GLD)

Gold logged the largest gain in nearly a month, spurred by indications that inflation was slowing down more rapidly than anticipated, which in turn boosted gold and other precious metals. The cooling inflation is supportive of gold, which 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 $54.3 billion and a heavy volume of about 8 million shares a day. SPDR Gold Trust ETF charges 40 bps in fees per year from investors and has a Zacks ETF Rank #3.

iShares Russell 2000 ETF (IWM)

The beaten-down small caps rallied, with traders erasing bets on more Fed hikes. The Russell 2000 Index delivered its best performance since Nov 10, 2022. iShares Russell 2000 ETF provides exposure to a broad basket of 1,978 stocks by tracking the Russell 2000 Index, with none holding more than 0.6% of the assets. iShares Russell 2000 ETF is the most popular and liquid choice in the small-cap space, with AUM of $50 billion and an average trading volume of around 30 million shares.

iShares Russell 2000 ETF charges 19 bps in annual fees and has a Zacks ETF Rank #2 (Buy) with a Medium risk outlook.

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