Something is definitely ailing small-cap stocks and those ailments could get worse before they improve. Just look at the Russell 2000 Index, which is lower by almost 6.4% this month, a loss that is 135 basis points worse than that of the large-cap S&P 500.
Perhaps surprisingly, there has not been any unusual activity recently in the Direxion Daily Small Cap Bear 3X Shares (NYSE: TZA). TZA is designed to deliver triple the daily inverse returns of the Russell 2000 Index.
Perhaps traders should be paying more attention to the bearish small-cap fund. After all, small-caps stocks are betraying their reputation as providing some insulation from trade tensions. Rather, the group is slumping against that backdrop and amid declining interest rates, a scenario that is heavily pressuring financial services-heavy small-cap benchmarks.
Why It's Important
There's another reason for short-term traders to consider the bearish TZA: rising debt burdens among smaller companies. Sure, some of those companies can get away with mounting debt with interest rates being low, but in an environment where investors are prizing quality traits, big piles of liabilities could keep some investors away from small caps.
“Even before the [spike in the first quarter] . . . net debt to cap for the Russell 2000 has been near past peaks in recent years, due to a sharp escalation in long-term debt,” reports MarketWatch, citing RBC equity strategist Lori Calvasina.
Alright, so the market can, perhaps, tolerate mounting debt at small companies because interest rates are low, but there's another reason TZA looks appealing: negative earnings revisions for Russell 2000 companies.
“These downward revisions have already begun, with the share of earnings revisions to the downside hitting 71% by early August, according to RBC, while the share of negative revenue revisions were at 68%,” according to MarketWatch.
With the Russell 2000 laboring almost 4% below its 200-day moving average and risk-off pall hanging over the market, TZA may be the best way to play small-cap stocks over the next several weeks, though data indicate the Direxion Dailly Small Cap Bull 3X Shares (NYSE: TNA) has recently taken in new money. That could be a sign some traders are betting small caps are ready to rebound.
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