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4 ETF Ways to Play the Small-Cap Surge for Big Gains

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Amid renewed market rally, the small-cap segment of the broader U.S. stock market is outperforming. This is especially true as the Russell 2000 Index has risen more than 12% since a recent low on Sep 23, almost twice the tech-heavy Nasdaq Composite Index. The outperformance came on the back of a potential coronavirus vaccine, hopes for further stimulus and a recovering economy.

Additionally, Democratic challenger Joe Biden’s widening lead in the polls over President Donald Trump is also driving the stocks higher. Market speculators believe that if the Democrats take the White House and both chambers of Congress, the fiscal stimulus will be enacted without big delays, which would give support to stocks and dollar. The renewed focus on domestic issues and policies will benefit small caps more as these are closely tied to the U.S. economy and generate most of their revenues from the domestic market. Being U.S. focused, a rising dollar will have a negligible impact on these pint-sized companies.

According to research by Citi strategist Scott Chronert, the average return for the Russell 2000 is 15% in the year after a presidential election since 1980. This is about 4 percentage points better, on average, than large-cap stocks (read: Here's Why Small-Cap ETFs Are Hitting New Highs).

Further, the super-easy monetary policy has been driving the small-cap rally. In the Fed’s latest policy meeting, Chairman Jerome Powell kept U.S. interest rates near zero and pledged to keep rates at lower levels until the end of 2023. A low interest rate bodes well for small-cap stocks as it pushes up economic activities and results in higher spending, thus boosting domestically focused companies.

The bullish trend is likely to continue at least for the rest of the year. According to Sundial Capital Research, historical patterns spanning four decades indicate the Russell 2000 Index’s spike augurs more gains in the month ahead. Bank of America analysis showed that the small caps are trading at a 26% discount to large peers — the widest in about 20 years — and are similarly cheaper than mid caps. As such, the current levels indicate the best valuation entry point for small caps since March.

How to Play?

Given this, investors are seeking to capitalize this opportune moment for big gains in a short span. For them, a leveraged play on small caps could be an excellent idea as these could lead to huge gains in a very short timeframe when compared to simple products. Below we highlight several products that could garner huge profits from the soaring small-cap stocks in a short span (see: all the Small Caps ETFs here):

ProShares Ultra Russell2000 (UWM - Free Report)

This product provides two times (2X) exposure to the daily performance of the Russell 2000 Index. It has been able to manage $131.5 million in its asset base and trades in a good volume of about 314,000 shares per day on average. Expense ratio is 0.95%. UWM has gained 14.9% in a month.

ProShares Ultra SmallCap600 (SAA - Free Report)

This fund seeks to deliver two times the performance of the S&P SmallCap 600. It is an unpopular and illiquid option in the leveraged small-cap space with AUM of $15.9 million and an average daily volume of 1,000 shares. It charges 95 bps in annual fees and has gained 12.5% in a month.

Direxion Daily Small Cap Bull 3x Shares (TNA - Free Report)

This product provides a triple leveraged play to the small-cap Russell 2000 Index, charging 95 bps in fees and expenses. It has amassed $919 million in its asset base and sees solid volume of 12.6 million shares a day on average. TNA has surged 22.1% in the same time frame (read: Beat Election Uncertainty With Top Small-Cap ETFs).

ProShares UltraPro Russell2000 (URTY - Free Report)

This fund also provides a triple exposure to the small-cap Russell 2000 Index with a similar expense ratio. However, it is less popular and less liquid than TNA with AUM of $174.5 million and average daily volume of 992,000 shares. URTY has climbed 22.1% in a month.

Bottom Line

As a caveat, investors should note that these products are extremely volatile and suitable only for short-term traders. Additionally, the daily rebalancing — when combined with leverage — may make these products deviate significantly from the expected long-term performance figures (see: all the Leveraged Equity ETFs here).

Still, for ETF investors who are bullish on the small-cap space for the near term, either of the above products can be an interesting choice. Clearly, a near-term long could be intriguing for those with high-risk tolerance, and a belief that the “trend is the friend” in this corner of the investing world.

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