Small-Cap ETFs Look Set to Resume 2019 Uptrend

Positive U.S. economic data leads to small-cap breakout

Just as the stock market enters the "sell in May and go away" period, which historically represents six months of underperformance between May and October, small-cap exchange-traded funds (ETFs) staged a technical breakout above crucial resistance on Friday, May 3.

Small-cap companies, which typically have a higher degree of exposure to the U.S. economy and rising interest rates compared to their larger counterparts, have received a boost recently from better-than-expected gross domestic product (GDP) growth, upbeat consumer confidence and buoyant employment data. The positive readings signal resilient economic activity in the United States amid a backdrop of slower global economic growth and steady inflation.

"At a time of lingering U.S.-Chinese trade uncertainty and weak economic data everywhere from Germany to Korea to Japan, strong U.S. data acts as an insurance policy against further global economic weakness. And with inflation still subdued, it's too early to start worrying about Fed rate hikes again," Alec Young, managing director of global market research at FTSE Russell, told CNBC.

Traders who want to buck the well-known Wall Street adage and position for a recommencement of the uptrend that saw small-cap stocks register their best start to a year since 1987 should run their eye over these three small-cap ETFs.

Direxion Daily Small Cap Bull 3X Shares (TNA)

Created at the height of the financial crisis in 2008, the Direxion Daily Small Cap Bull 3X Shares (TNA) aims to return three times the daily performance of the Russell 2000 Index. The fund provides exposure to roughly 2,000 U.S. small-cap companies, with a 17.08% tilt toward the financial sector. Deep liquidity of nearly 4 million shares traded daily and a narrow 0.03% average spread make the fund suitable for traders who want an aggressive short-term bullish bet on small-cap stocks. TNA rebalances daily, which may cause returns to deviate from the fund's advertised leverage due to the effect of compounding. As of May 6, 2019, the ETF has assets under management (AUM) of $804.08 million, issues a 0.22% dividend yield and is up 56.69% year to date (YTD). Although the fund charges a pricey 1.14% management fee, it shouldn't overly affect short holding periods.

TNA shares trended sharply higher throughout January and February from their bear market low set in late December 2018. Since then, the price has consolidated to form an ascending triangle that suggests a continuation of the early 2019 bullish price action. The fund gave a buy signal Friday when it closed above the pattern's upper trendline and the 200-day simple moving average (SMA). Those who trade the breakout should book profits on a move to $90, where the ETF may encounter resistance from a horizontal line connecting a series of prices over the past 16 months. Place a stop-loss order just below the ascending triangle pattern's lower trendline to protect trading capital.

Chart depicting the share price of Direxion Daily Small Cap Bull 3X Shares (TNA)

ProShares Ultra Russell2000 (UWM)

With AUM of $211.78 million, the ProShares Ultra Russell2000 (UWM) seeks to return two times the daily investment results of the Russell 2000 Index. This short-term tactical instrument that launched in 2007 suits intraday and swing traders who want to position for outperformance in the small-cap and micro-cap space. UWM delivers in terms of trading costs with a daily dollar volume of $20.02 million and a razor-thin 0.04% spread. Weightings are spread relatively evenly across the fund's portfolio, with no holding taking up more than a 0.40% allocation. UWM is up 36.39% on the year and yields 0.35% as of May 6, 2019. The ETF's expense ratio of 0.95% sits just above the 0.92% category average.

A broad inverse head and shoulders pattern has formed on UWM's chart over the past seven months that places the ETF's price roughly 20% below its 52-week high. Buyers pushed the price above the bottoming pattern's neckline in Friday's trading session, which could reignite the January and February rally. Traders who take a long position should think about setting a take-profit order near the late August 2018 swing high at $88.82. Manage risk by cutting losses if the price fails to hold the 50-day SMA.

Chart depicting the share price of the ProShares Ultra Russell2000 (UWM)

iShares Core S&P Small-Cap ETF (IJR)

The iShares Core S&P Small-Cap ETF (IJR) attempts to provide similar returns to the S&P SmallCap 600. Its benchmark comprises liquid small-cap companies that represent about 3% of the publicly traded equity market. With an average spread of just 0.01%, $250 million in daily dollar volume and a super low 0.07% management fee, the fund suits all trading styles, from capturing short one-day jumps to profiting from multi-month uptrends. IJR offers reasonable diversification, with its top 10 holdings accounting for only 5.02% of the portfolio. Financials and industrials command the largest sector exposure at 24.55% and 19.16%, respectively. As of May 6, 2019, the ETF offers a 1.39% dividend yield and has a YTD return of just over 15%.

Friday's convincing breakout above an ascending triangle and the 200-day SMA indicates the bulls have returned after a two-month hiatus. Although the 200-day SMA sits above the 50-day SMA, the latter has recently converged toward the longer-term moving average, which may result in a golden cross signal in the coming weeks. Traders who buy the ETF should look for a test of the 52-week high at $89.56. A stop positioned under this month's low at $78.85 provides an excellent risk/reward ratio of 1:3.5 ($8.33:$2.38), assuming an entry at Friday's closing price of $81.23.

Chart depicting the share price of the iShares Core S&P Small-Cap ETF (IJR)
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