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An Avenue For Small-Cap Promise, Relatively Speaking

ETF Professor

Through the end of April, large-cap stocks outpaced their small-cap rivals by a modest percentage, but those margins expanded last month and over the past three months.

However, smaller stocks are showing some signs of life and the Direxion Russell Small Over Large Cap ETF (NYSE: RWSL) could prove useful should smaller stocks commence outpacing large caps by significant margins.

What Happened

RWSL, which debuted in January, tracks the Russell 2000/Russell 1000 150/50 Net Spread Index. The aim of that index is to “provide a vehicle for investors looking to efficiently express a small-capitalization over large-capitalization investment view by overweighting exposure to the Long Component and shorting exposure to the Short Component,” according to Direxion.

RWSL is not a complex strategy. The ETF has a 150 percent long position in the Russell 2000 Index, one of the most widely observed small-cap benchmarks; and a 50 percent short position in the Russell 1000 Index to attain net exposure of 100 percent.

Why It's Important

“It has undeniably been quite an extraordinary first four months of the year for broad U.S. markets,” said Direxion in a recent note. “The Russell 1000 gained 18.60% (total return) through April, and Small Cap stocks, as measured by the Russell 2000, provided 18.48% through the end of April. To put that into perspective, the last time we saw both Large Caps and Small Caps provide greater than 18% total returns over four months’ time was in December of 2010.”

While the Russell 2000 lost nearly 2 percent on Tuesday, the small-cap index has held up slightly better than large-cap equity gauges to start May as global markets have been roiled by ongoing trade tensions between the U.S. and China.

The relative sturdiness of small-cap stocks in the face of international headline risk is not surprising. Traditionally, U.S. small caps derive the bulk of their revenue in the U.S., a trait that provides a buffer amid flaring trade tensions.

What's Next

“While Large Cap and Small Cap stocks show very similar returns through the close of business on April 30, leadership shifted from Small Caps to Large Caps in a noticeable way,” said Direxion. “Through the month of January, Small Caps provided almost 3% in outperformance relative to Large Caps. Whether it was driven by a flight to quality, or simply market leadership from Large Cap Technology names, Small Caps gave all of this outperformance back over the trailing three months.”

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