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Short Small-Cap ETFs as U.S. May Face Technical Recession

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Just as the coronavirus-induced global market selloffs started, the pain for already-struggling U.S. small-cap stocks aggravated. U.S. Small-cap ETF iShares Russell 2000 ETF (IWM - Free Report) was off 28.8% in the past month (as of Mar 13, 2020), which was the most acute if we compare with leading global large-cap-oriented ETFs like S&P 500-based SPY (down 20.2%), Dow Jones-based (DIA - Free Report) (down 20.9%), Nasdaq-100-based (QQQ - Free Report) (down 18%), Europe-based (VGK - Free Report) (down 25.4%), emerging markets-based (EEM - Free Report) (down 18.2%), Asia-based (AIA - Free Report) (down 14.4%) and all-world (ACWI - Free Report) (down 21.4%).

The situation has been the same over the 10-day timeframe, with IWM losing the most (down 18.5%). Notably, U.S. small-cap stocks lagged their larger cousins in 2019 as well. Will 2020 be another painful year for pint-sized stocks? (read: Investors Love These ETF Areas Amid Virus-Led Bear Market).

U.S. May Face Technical Recession in First-Half 2020

With people on quarantine and activities slowly coming to a halt, recession fears are tightening its grip on markets.The absence of goods and services amid the virus-led decline in productivity, city lockdowns, factory shutdowns, restrictions on travel and cancellation of events are naturally hurting concerned economies.

President Trump has now declared a national emergency, which intensifies worries for U.S. small-caps as these are more dependent on the domestic economy. The United States has more than 1,600 confirmed cases currently.

Sensing the severity of the situation, J.P. Morgan recently moved away from its earlier view and has projected a coronavirus-driven recession in the United States. The bank said its views of the coronavirus outbreak "have evolved dramatically in recent weeks." JPMorgan economists now expect U.S. GDP to contract by 2% in the first quarter and 3% in the second.

JPMorgan Chase earlier believed that “the market has gone ahead and priced in too severe of an adverse scenario.” Then there is Investment management firm Pimco, which expects a “technical recession” in the first part of the year. Technical recession refers to the sequential decline in GDP for two quarters in a row.

TS Lombard forecasts a “major recession” globally. Goldman Sachs warns U.S. markets will encounter a steeper decline going ahead and the U.S. GDP will contract 5% in the second quarter (read: Is the Acute ETF & Stock Selloff an 'Overreaction' or Justified?).

Moreover, the earnings picture is grimmer for small caps as depicted by the S&P 600 than the large caps. For first-quarter 2020, the S&P 500 is expected to report a 1.4% decline in earnings (excluding the impact of financial sector, the rate of decline would be 1.5%), per the Earnings Trends issued on Mar 12. Meanwhile, S&P 600 companies are likely to report a 4.6% earnings slump for Q1. Excluding the financial sector, S&P 600 may see an earnings recession of 22.4%.

If this was not enough, small-cap stocks are highly volatile in nature and thus susceptible to a steeper crash. So, if the U.S. economy enters into a recession in the coming days, small-cap stocks and ETFs may feel further pain.

Inverse Small-Cap ETFs in Focus

Amid the bloodbath in the small-cap space, inverse small-cap ETFs have gained in the past month. Below we highlight a few winners.

Direxion Daily Small Cap Bear 3X Shares (TZA - Free Report) – Up 124.6% in the Past Month

ProShares UltraPro Short Russell2000 (SRTY - Free Report) – Up 124.4%

ProShares UltraShort SmallCap600 SDD – Up 86.1%

ProShares UltraShort Russell2000 TWM – Up 78.3%

ProShares Short SmallCap600 (SBB - Free Report) – Up 33.5%

Proshares Short Russell2000 (RWM - Free Report) – Up 36.2%

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