Small-cap stocks have been on a tear over the past month, outperforming their large-cap counterparts by around 6% as investors bet on a domestic economic recovery amid hopes of a successful coronavirus vaccine and higher levels of stimulus spending. Cyclical sectors – like healthcare, industrials, and financials, which make up about half the small-cap proxy Russell 2000 index – typically shine during periods of improving economic growth and rising bond yields, according to Goldman Sachs.

Key Takeaways

  • Goldman Sachs says that cyclical stocks perform well during periods of improving economic growth and rising bond yields.
  • The iShares Russell 2000 ETF (IWM) has consolidated within a pennant pattern above a multi-year horizontal trendline, indicating further upside continuation.
  • The ProShares UltraPro Russell2000 (URTY) is coiling in a two-week pennant, suggesting that the fund is getting ready to propel higher.

The investment bank expects these conditions over the short term, saying that cyclical stocks traditionally outperform defensive names by up to 15% in this type of environment. Goldman says that there have been 15 of these periods since the financial crisis, each of which typically lasts for four months, per MarketWatch.

Traders can gain exposure to small-cap stocks through these two exchange-traded funds (ETFs) that track the Russell 2000 Index. Below, we review the metrics of each and identify key chart levels using technical analysis.

iShares Russell 2000 ETF (IWM)

Launched at the start of the millennium, the iShares Russell 2000 ETF has an investment mandate to provide similar returns to the Russell 2000 Index. To achieve this, the fund invests at least 90% of its huge $36.68 billion asset pool in stocks and depositary receipts that make up the underlying benchmark. The ETF holds more micro-cap stocks than the underlying index but tracks sector weightings closely, with financials, healthcare, and industrials commanding asset allocations of 22.03%, 18.85%, and 13.52%, respectively. Trading wise, deep liquidity and razor-thin penny spreads minimize transaction costs. As of Oct. 26, 2020, IWM yields 1.41% and is trading 13.19% higher over the past month.

For the past several weeks, the ETF's price has consolidated within a pennant pattern above a multi-year horizontal trendline, indicating further upside continuation in the short to medium term. Traders should consider using a measured move to book profits. To use this technique, calculate the distance in dollars of the impulsive wave preceding the pennant and add it to the top of the pattern (add $22.15 to $164.24 = $185.39 profit target). Protect capital by placing a stop beneath last week's low at $159.18 and amending the order to breakeven if the fund closes above its 2020 high at $170.56.

Chart depicting the share price of the iShares Russell 2000 ETF (IWM)
TradingView.com

An impulse wave pattern is a technical trading term that describes a strong move in a financial asset's price coinciding with the main direction of the underlying trend.

ProShares UltraPro Russell2000 (URTY)

The ProShares UltraPro Russell2000 ETF aims to provide three times the daily return of the Russell 2000 Index, making it a suitable instrument for those wanting to take a leveraged bet on the small-cap space. Daily turnover of nearly 1 million shares, coupled with an average 0.08% spread, allows active traders to enter and exit positions with ease while minimizing slippage. Given the fund's tactical mission, its high 0.95% expense ratio shouldn't bother short-term stays. URTY holds net assets of $173.73 million and issues a modest 0.33% dividend yield as of Oct. 26, 2020.

URTY also tracks the Russell 2000 – therefore, its chart closely mirrors that of IWM. A coiling two-week pennant finds a confluence of support from the August swing high and 200-day simple moving average (SMA), suggesting that the price is getting ready to propel higher. Those who take a trade at these levels should think about setting a take-profit order at $58.50, where the ETF may run into resistance near the lower trendline of a 2019 trading range. Be prepared to cut losses if the price fails to hold above the pennant pattern's low at $42.92. 

Chart depicting the share price of the ProShares UltraPro Russell2000 (URTY)
TradingView.com

Support, or a support level, refers to the price level that an asset does not fall below for period of time. An asset's support level is created by buyers entering the market whenever the asset dips to a lower price.

Disclosure: The author held no positions in the aforementioned securities at the time of publication.