Small Cap Stocks: Short-term Pain for Long-term Gain?
Editor's note: Any and all references to time frames longer than one trading day are for purposes of market context only, and not recommendations of any holding time frame. Daily rebalancing ETFs are not meant to be held unmonitored for long periods. If you don't have the resources, time or inclination to constantly monitor and manage your positions, leveraged and inverse ETFs are not for you.
Over the past couple years, small cap stocks have underperformed their large cap counterparts. But since the start of 2023, we’ve seen an uptick in relative performance by small cap shares. That is, the Russell 2000 Index has outperformed the S&P 500® Index since then. But Fed Chair Powell’s recent testimony about more rate hikes to come sent stocks swooning lower. Was this a short-term overreaction by equity traders? Or was it the start of a more pronounced leg lower in stocks?
Is Lack of Liquidity all Bears Need?
Powell’s hawkish comments sent the odds of rate hikes surging. Markets are now pricing in a 50-basis point rate hike at the March 22 Federal Open Market Committee(FOMC) meeting, which is 25-basis points higher than just a week ago.
Raising rates lowers market liquidity, and the Fed’s apparent strategy here is to attack the wealth effect – which centers on the tendency of individuals to spend more when they feel wealthier. The thinking is that if asset prices are down, people will spend less.
The challenge the Fed is facing is that consumer demand hasn’t dropped much yet. This could be attributed to the resilient labor market, as unemployment rates hover near record lows. The next report on the employment situation in the U.S. is on April 7. If the labor market continues to display strength, it may embolden an already hawkish Fed.
For traders that favor the bearish outlook for equities, Direxion offers a Daily Small Cap Bear 3X Shares (Ticker: TZA), which seeks to track 300% of the inverse (or opposite), before fees and expenses, of the daily performance of the Russell 2000 Index*.
Below is a daily chart of TZA as of March 9, 2023.
Source: TradingView.com
Candlestick charts display the high and low (the stick) and the open and close price (the body) of a security for a specific period. If the body is filled, it means the close was lower than the open. If the body is empty, it means the close was higher than the open.
The performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate. An investor’s shares, when redeemed, may be worth more or less than their original cost; current performance may be lower or higher than the performance quoted. For the most recent month-end performance go to Direxion.com/etfs. For standardized performance click here.
Can Macro Tailwinds Boost Small Caps?
The outlook isn’t all doom and gloom for small caps. The sector tends to do better in a rising Dollar environment, as small cap firms tend to have less foreign exchange risk than large caps do. The Dollar’s strength boosts the earnings appeal for small cap stocks, and much of the reserve currency’s strength is contingent on interest rates being as high as they are.
Given the tendency of interest rates to follow inflation rates, traders need to keep a close watch on the Consumer Price Index (CPI) and Producer Price Index (PPI) reports of March 14 and 15, respectively. If they come in at or above estimates, it could bolster the Fed’s rate hike trajectory, which could strengthen the Dollar even more.
In such a scenario, Direxion’s Daily Small Cap Bull 3X Shares (Ticker: TNA), which seeks to track 300%, before fees and expenses, of the daily performance of the Russell 2000 Index, could catch a nice bid.
Below is a daily chart of TNA as of March 9, 2023.
Source: TradingView.com
Candlestick charts display the high and low (the stick) and the open and close price (the body) of a security for a specific period. If the body is filled, it means the close was lower than the open. If the body is empty, it means the close was higher than the open.
The performance data quoted represents past performance. Past performance does not guarantee future results. The investment return and principal value of an investment will fluctuate. An investor’s shares, when redeemed, may be worth more or less than their original cost; current performance may be lower or higher than the performance quoted. For the most recent month-end performance go to Direxion.com/etfs. For standardized performance click here.
Various Market Cap Plays
Traders looking to speculate on bigger cap sectors may consider the Direxion’s Daily S&P 500® Bull 3X Shares (Ticker: SPXL) and Daily S&P 500® Bear 3X Shares (Ticker: SPXS), which seek to track 300% or 300% of the inverse (or opposite), respectively, of the daily performance of the S&P 500® Index*. There’s even the Direxion Daily Mid Cap Bull 3X Shares (Ticker: MIDU), which looks to track 300%, before fees and expenses, of the daily performance of the S&P MidCap 400 Index*.
An investor should carefully consider a Fund’s investment objective, risks, charges, and expenses before investing. A Fund’s prospectus and summary prospectus contain this and other information about the Direxion Shares. To obtain a Fund’s prospectus and summary prospectus call 866-476-7523 or visit our website at www.direxion.com. A Fund’s prospectus and summary prospectus should be read carefully before investing.
Leveraged and Inverse ETFs pursue daily leveraged investment objectives which means they are riskier than alternatives which do not use leverage. They seek daily goals and should not be expected to track the underlying index over periods longer than one day. They are not suitable for all investors and should be utilized only by sophisticated investors who understand leverage risk and who actively manage their investments.
The Russell 2000® Index measures the performance of approximately 2,000 small-capitalization companies in the Russell 3000® Index, based on a combination of their market capitalization.
The S&P 500® Index is designed to be comprised of stocks that are the 500 leading, large-cap U.S. listed issuers. The securities are selected on the basis of market capitalization, financial viability of the company, sector representation, public float, liquidity and price of a company’s shares outstanding. The Index is a float-adjusted, market capitalization-weighted index.
The S&P MidCap 400® Index is a float-adjusted market capitalization weighted index that measures the performance of 400 mid-sized companies in the United States.
One cannot directly invest in an index.
The Russell 2000® Index is a trademark of Frank Russell Company (“Russell”) and has been licensed for use by the Trust. The Direxion Daily Small Cap Bull and Bear 3X Shares are not sponsored, endorsed, sold or promoted by Russell. Russell makes no representation regarding the advisability of investing in the Direxion Daily Small Cap Bull and Bear 3X Shares.
The S&P 500 Index and S&P MidCap 400 Index are products of S&P Dow Jones Indices LLC ("SPDJI"), and has been licensed for use by Rafferty Asset Management, LLC ("Rafferty"). Standard & Poor’s® and S&P® are registered trademarks of Standard & Poor’s Financial Services LLC ("S&P"); Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC ("Dow Jones"); and these trademarks have been licensed for use by SPDJI and sublicensed for certain purposes by Rafferty. Rafferty’s ETFs are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability for any errors, omissions, or interruptions of the S&P 500® Index or the S&P MidCap 400 Index.
Direxion Shares Risks – An investment in each Fund involves risk, including the possible loss of principal. Each Fund is non-diversified and includes risks associated with the Funds’ concentrating their investments in a particular industry, sector, or geographic region which can result in increased volatility. The use of derivatives such as futures contracts and swaps are subject to market risks that may cause their price to fluctuate over time. Risks of each Fund include Effects of Compounding and Market Volatility Risk, Leverage Risk, Market Risk, Counterparty Risk, Rebalancing Risk, Intra-Day Investment Risk, Other Investment Companies (including ETFs) Risk, Cash Transaction Risk, Tax Risk, and risks specific to investment in micro-cap, small- and/or mid-capitalization securities. Investing in micro-capitalization companies are significantly more volatile as they face greater risk of business failure than companies considered small and/or mid-capitalization companies. Investing in small and/or mid-capitalization securities involves greater risks and the possibility of greater price volatility than investing in larger, more-established companies. Additional risks include, for the Direxion Daily Small Cap Bull 3X Shares, Daily Index Correlation Risk, and for the Direxion Daily Small Cap Bear 3X Shares, Daily Inverse Index Correlation Risk, and risks related to Shorting. Please see the summary and full prospectuses for a more complete description of these and other risks of each Fund.
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