Small-Cap Bear ETFs Look to Be Waking From Hibernation

Large caps typically outperform small caps toward the end of a bull market

The Russell 2000 Index, a proxy for small-capitalization stocks, opened 2019 by recording eight consecutive positive weeks as investors snapped up oversold issues after December's market meltdown. Year to date (YTD), the Russell 2000 sports gains of 15.31%, outperforming the market's broad-based benchmark, the S&P 500 Index, by more than 2% over the same period as of March 20, 2019.

Although small-cap stocks have led the way higher so far in the first quarter, they remain more exposed to economic cycles, as they typically carry more debt than their large-cap counterparts, which makes them sensitive to rising interest rates and wage inflation. Moreover, because most small-cap companies generate the majority of their revenue within the United States, they may play second fiddle to conglomerates that register substantial sales abroad if Washington and Beijing settle on a long-awaited trade deal.

"Large caps typically outperform small caps late cycle," President and CEO of Strategic Wealth Partners Mark Tepper told CNBC's Trading Nation program. "When the economy slows and eventually contracts, those companies with high debt levels are going to get hit the hardest. Cash flow slows, rates go up, and that's a recipe for trouble. Beyond that, wages are going up, and that's going to eat into margins," Tepper added.

From a technical standpoint, a bearish engulfing candlestick formed on the Russell 2000 chart in Tuesday's trading session that signals lower prices ahead. Traders can fade this index by using one of the following three small-cap bear exchange-traded funds (ETFs). Let's explore each in further detail.

Direxion Daily Small Cap Bear 3X ETF (TZA)

Launched in 2008, the Direxion Daily Small Cap Bear 3X ETF (TZA) seeks to return three times the inverse daily performance of the Russell 2000 Index – a benchmark that comprises 2,000 small-capitalization companies. The fund achieves its leveraged return through the use of swap agreements, futures contracts and/or short positions. TZA has $321.87 million in net assets, a tight 0.10% average spread and daily trading volume of nearly 9 million shares. These metrics make it a suitable instrument for traders who want an aggressive short-term bet against small caps. The ETF, which charges a 1.11% management fee and issues a 1.02% dividend yield, is down nearly 40% year to date (YTD) as of March 20, 2019. TZA rebalances daily, which may cause returns to deviate from the fund's advertised leverage due to the effect of compounding.

TZA's share price has formed an Everest-like pattern over the past six months, with the ETF looking like it's nearing base camp in recent trading sessions. After opening below Monday's low, the fund rallied to close 1.76% higher Tuesday – indicating a possible short-term reversal to the upside. Traders who buy here should consider setting a take-profit order at $12.50, where the price may encounter resistance from the October and November swing highs. Cut losing trades if the fund closes below the trendline stretching back to late August.

Chart depicting the share price of the Direxion Daily Small Cap Bear 3X ETF (TZA)

ProShares UltraShort Russell2000 (TWM)

With assets under management (AUM) of $80.92 million, the ProShares UltraShort Russell2000 (TWM) tracks the same benchmark index as TZA but seeks to provide two times the inverse daily performance of the Russell 2000 Index. The fund's razor-thin 0.01% average spread and ample liquidity make it ideal for traders who want an intraday bet against small-cap stocks. TWM's expense ratio of 0.95% falls in line with the 0.94% category average. Trading at $15.29 and paying a 1.01% dividend, the ETF has fallen 26.53% for the year as of March 20, 2019.

The bears took total control of TWM's share price between late December and late February, which saw the fund sink nearly 40% over the period. Since that time, the price has traded mostly sideways and within proximity to a seven-month uptrend line. Those who open a long position should book profits if the price tests the $18 level – an area where it may find resistance from a horizontal line connecting a series of significant price action points over the past 12 months. Think about placing a stop-loss order beneath the February swing low.

Chart depicting the share price of the ProShares UltraShort Russell2000 (TWM)

ProShares Short Russell2000 ETF (RWM)

Formed in January 2007, the ProShares Short Russell2000 (RWM) ETF aims to return the inverse daily returns of the Russell 2000 Index. The underlying index has a 20% tilt toward the financial sector that makes the fund suitable for traders who want a modest bet against small-cap financial companies. Both day and swing traders will appreciate the ETF's 0.02% spread and average daily dollar volume of $21.85 million. As of March 20, 2019, RWM yields 1.01%, charges a management fee of 0.95% and has a YTD return of -13.85%.

Roughly equal volume has accompanied the rise and fall in RWM's share price. Although the fund sits below a trendline extending back to late December, yesterday's intraday reversal on the 200-day simple moving average (SMA) suggests that the bears may be awakening from a near three-month hibernation. Traders should look for the fund's price to test key resistance at $43. Place a stop slightly beneath this month's low at $39.47 to protect trading capital. If the price climbs to the 50-day SMA, consider moving stop orders to breakeven point.

Chart depicting the share price of the ProShares Short Russell2000 ETF (RWM)
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