Editor’s note: Any and all references to time frames longer than one trading day are for purposes of market context only, and not recommendations of any holding time frame. Daily rebalancing ETFs are not meant to be held unmonitored for long periods. If you don’t have the resources, time or inclination to constantly monitor and manage your positions, leveraged and inverse ETFs are not for you.
The recent 25-basis point* rate hike by the Federal Reserve brought rates back above 5% for the first time since 2007. The rate hike campaign has been in effect since the beginning of 2022, and has been one of the most aggressive ones in U.S. monetary history. Inflation levels have come down in response, but remain stubbornly elevated. When it comes to inflation expectations, one of the primary markets to watch is energy. The price of Crude Oil just dropped to its lowest level since November 2021. Could this be the signal the Fed was waiting for?
Energy: Primed for a Bounce?
A few weeks back, OPEC announced a major production cut that sent oil prices soaring in the near-term. But the bounce failed, and prices dropped back down to new lows. Normally, a reduction in supply means higher prices. In markets, when bullish developments lead to bearish outcomes, it usually means something else is unfolding underneath the surface.
With the latest rate hike, the Fed has basically matched the year-over-year inflation rate. The most recent consumer price index* (CPI) publication on April 12 showed that inflation rose 4.98% year-over-year in March. With the Fed set to hold interest rates between 5.00-5.25% over the next few months, we need to keep a close watch on the upcoming inflation reports to make sure we don’t see another uptick. The next CPI report is set to be released on May 10. If it comes in above 5%, the rate hike saga may not be over.
This ties into energy names because not only is crude oil the primary driver of inflation expectations, but it also drives energy stocks. With prices near multi-month lows, we can’t rule out a technical bounce higher for energy names. Traders that think the energy market could catch a bid here may find an opportunity in Direxion’s Daily Energy Bull 2X Shares (Ticker: ERX), which seeks daily investment results, before fees and expenses, of 200% of the performance of the Energy Select Sector Index*. There is no guarantee that the fund will meet the stated investment objective.
Below is a daily chart of ERX as of May 4, 2023.
Source: TradingView.com
Candlestick charts display the high and low (the stick) and the open and close price (the body) of a security for a specific period. If the body is filled, it means the close was lower than the open. If the body is empty, it means the close was higher than the open.
The performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate. An investor’s shares, when redeemed, may be worth more or less than their original cost; current performance may be lower or higher than the performance quoted. For the most recent month-end performance go to Direxion.com/etfs. For standardized performance click here.
Could Inflation Lead to Deflation?
The other side of the OPEC production cut debate is that the organization simply does not have the same pricing power as it once did. The oil market is a global one, and if we look at the Baker Hughes Rig Count *in the U.S. and abroad, we see that there’s been a notable uptick in the past year.
The number of international rigs in operation between March 2022 and March 2023 increased by 115 to 930. In the U.S., that number increased by 57 year-over-year to 755. Thus, there is an argument to be made that oil production has picked up significantly, adding to the global output. Higher supply would mean lower prices, and could give the Fed the exact scenario they’ve wanted – a decrease in prices.
In this situation of a prolonged decline in energy prices, oil companies could see a big drop in profits. Direxion’s Daily Energy Bear 2X Shares (Ticker: ERY), which seeks daily investment results, before fees and expenses, of 200% of the inverse (or opposite) of the daily performance of the Energy Select Sector Index, could see a nice bid. There is no guarantee the fund will meet its stated investment objective.
Below is a daily chart of ERY as of May 4, 2023.
Source: TradingView.com
Candlestick charts display the high and low (the stick) and the open and close price (the body) of a security for a specific period. If the body is filled, it means the close was lower than the open. If the body is empty, it means the close was higher than the open.
The performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate. An investor’s shares, when redeemed, may be worth more or less than their original cost; current performance may be lower or higher than the performance quoted. For the most recent month-end performance go to Direxion.com/etfs. For standardized performance click here.
*Definitions & Index Descriptions | Direxion
The Energy Select Sector Index is a product of S&P Dow Jones Indices LLC (“SPDJI”), and has been licensed for use by Rafferty Asset Management, LLC (“Rafferty”). Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC (“Dow Jones”); and these trademarks have been licensed for use by SPDJI and sublicensed for certain purposes by Rafferty. Rafferty’s ETFs are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the Energy Select Sector Index.
The Energy Select Sector Index is provided by S&P Dow Jones Indices and includes domestic companies from the energy sector which includes the following industries: oil, gas and consumable fuels; and energy equipment and services.
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Leveraged and Inverse ETFs pursue daily leveraged investment objectives which means they are riskier than alternatives which do not use leverage. They seek daily goals and should not be expected to track the underlying index over periods longer than one day. They are not suitable for all investors and should be utilized only by sophisticated investors who understand leverage risk and who actively manage their investments.
Direxion Shares Risks – An investment in each Fund involves risk, including the possible loss of principal. Each Fund is non-diversified and includes risks associated with the Funds’ concentrating their investments in a particular industry, sector, or geographic region which can result in increased volatility. The use of derivatives such as futures contracts and swaps are subject to market risks that may cause their price to fluctuate over time. Risks of each Fund include Effects of Compounding and Market Volatility Risk, Leverage Risk, Market Risk, Counterparty Risk, Rebalancing Risk, Intra-Day Investment Risk, Other Investment Companies (including ETFs) Risk, Cash Transaction Risk, Tax Risk, and risks specific to investment in the securities of the Energy Sector. Companies that engage in energy-related businesses and companies primarily involved in the production and mining of coal, development and production of oil, gas and consumable fuels and provide drilling and other energy resources production and distribution related services are subject to risks of legislative or regulatory changes, adverse market conditions and/or increased competition affecting the energy sector. Additional risks include, for the Direxion Daily Energy Bull 2X Shares, Daily Index Correlation Risk, and for the Direxion Daily Energy Bear 2X Shares, Daily Inverse Index Correlation Risk, and risks related to Shorting. Please see the summary and full prospectuses for a more complete description of these and other risks of each Fund.
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