Small capitalization companies are having a hard time catching up with their large capitalization counterparts, and some even argue that smaller stocks will keep on underperforming. Investors with a pessimistic outlook on the small-cap asset category can utilize inverse exchange traded funds to hedge against further declines.
Oppenheimer Asset Management technician Ari Wald argues that a good short-term strategy would be to short the Russell while going long the S&P 500, reports Patti Domm for CNBC.
“Small caps did well in the last few years,” Domm said in the article. “In the last couple of months, we’ve seen the trend toward big caps.”
Last week, the Russell 2000 experienced its worst weekly performance in two years, and analysts expect more pain ahead. The iShares Russell 2000 ETF (NYSEArca: IWM) declined 3.9% over the past week and is up 0.4% year-to-date. In comparison, the S&P 500 Index dipped 0.9% over the past week and is up 7.6% this year. [Small-Cap ETF Pauses, Waits on New Highs]
“The Russell is the only one of the four major indices that didn’t confirm by closing at a new high,” Paul LaRosa, market technician at Maxim Group., said in the article. “We traded intra-day above the 1212 level but didn’t close above it. That is what I think led to a negative divergence selloff last week.”
Technical analysts are also pointing to potential trend-reversal as small-caps start showing a head and shoulders pattern formation.
“There was a head and shoulders forming in the Russell, which still could be there. It’s definitely possible the market goes lower,” LaRosa added. “There’s always a reason. We’re in earnings season. It has been the weakest of the major indices, and it was the one that refused to confirm the uptrend.”
Consequently, investors interested in hedging against further declines in the Russell 2000 can take a look at inverse or short ETF options. For instance, the ProShares Short Russell 2000 ETF (NYSEArca: RWM) reflects the -1x or -100% daily performance of the Russell 2000 Index. Over the past wee, RWM increased 4.0%.
For the more aggressive trader, there are a number of leveraged inverse options available as well. The ProShares UltraShort Russell 2000 ETF (NYSEArca: TWM), which tracks the -2x or -200% daily performance of the Russell 2000, jumped 8.1% over the past week. The Direxion Daily Small Cap Bear 3X Shares (NYSEArca: TZA), which tracks the -3x or -300% daily performance of the Russell 2000, surged 12.1% over the past week.
Potential investors should be aware that these types of inverse and leveraged fund should not be used for long-term, buy-and-hold positions since the the funds rebalance on a daily basis, and due to the compounding effects, the ETFs can diverge from their target strategies over long periods.
For more information on small capitalization stocks, visit our small-cap category.
Max Chen contributed to this article.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.