As the large-cap proxy S&P 500 set an all-time high on Feb. 19, its small-cap counterpart – the Russell 2000 – remained 1% below its August 2018 peak. Moreover, throughout the recent pandemic-driven sell-off, small caps have continued to underperform blue chips by as much as 8%.
In times of uncertainly, investors tend to shun smaller companies, as they often present additional risk due to tighter profit margins and an inability to manage costs caused by a lack of buying power. Also, years of record-low interest rates have led to smaller firms increasing their debt levels, making them more susceptible to economic downturns.
According to Bank of America Global Research and FactSet data, the net debt-to-EBITDA ratio for the Russell 2000, excluding financial companies, was 4.32 at the end of February, up from 2.13% in 2012, per The Wall Street Journal. The data also revealed that the number of companies in the Russell 2000 that aren't profitable has steadily risen over the past eight years and sits at 29% – a level not seen since shortly after the Great Recession.
Those who want to bet against the Russell 2000 Index should take a closer look at three inverse exchange-traded funds (ETFs) that rise when small-cap stocks fall. Let's review the specifics of each fund and turn to the charts to identify possible trading opportunities.
ProShares Short Russell2000 ETF (RWM)
With assets under management (AUM) of $297.36 million and charging a 0.95% management fee, the ProShares Short Russell2000 ETF (RWM) aims to deliver the inverse daily performance of the Russell 2000 Index. More than 1 million shares change hands most days on a penny spread, making the fund a popular choice for single-day tactical trading. RWM issues a 1.38% dividend yield and has risen nearly 30% so far this year as of March 30, 2020.
The ETF's share price broke out from a year-long sideways market earlier this month on above-average volume, indicating buyer participation. Last week's pullback to the 50% Fibonacci retracement level as measured from the Feb. 19 low to the March 19 high provides a "buy the dip" opportunity for swing traders. In terms of trade management, consider placing a stop-loss order beneath Thursday's low at $47.06 and booking profits if the fund tests its recent high just above $59.
ProShares UltraShort Russell2000 ETF (TWM)
The ProShares UltraShort Russell2000 ETF (TWM) seeks to return twice the inverse daily performance of the Russell 2000 Index. Health care and financials make up the underlying index's top weightings with respective allocations of 18.22% and 17.59%. Meanwhile, the fund's daily turnover of 4.2 million shares combined with razor-thin bid/ask spreads provides ample liquidity and seamless execution. As of March 30, 2020, TWM holds net assets of $101.63 million, charges a 0.95% management fee, and has jumped 51.10% year to date.
TWM shares have had a deeper retracement due to the effect of added leverage but still find support at the $19 area from the 61.8% Fibonacci retracement level. Active traders should look to take profits near the top of the Fibonacci grid around $30 while minimizing risk with a stop positioned underneath the March 9 breakout gap low at $17.94.
Direxion Daily Small Cap Bear 3X Shares ETF (TZA)
Launched at the height of the Global Financial Crisis, the Direxion Daily Small Cap Bear 3X Shares ETF (TZA) attempts to offer returns that correspond to three times the inverse daily performance of the Russell 2000 Index. The fund's additional leverage makes it a suitable instrument for those who want an aggressive short-term bet against small caps. Daily dollar volume over $225 million coupled with a tight 0.03% spread keep trading costs under control. Trading at $62.73 with nearly $400 million in net assets and offering a 1.12% yield, TZA has returned 61.86% on the year as of March 30, 2020.
Last week's selling tested the top of an extended trading range at $55 before the bulls stepped in to close the fund 10.54% higher on Friday as small caps resumed their downtrend. Provided that the ETF's price can hold above this closely watched support level, look for a move back up to the March high near $120. Close open positions if the fund fails to hold $55, as this invalidates the trade setup.