A new presidential administration and an inflection point for the Federal Reserve are adding a high degree of uncertainty to the market. That could bring forth heightened volatility. However, history shows that added volatility could pave the way for small-cap strength.
Year to date, the Russell 2000 is up more than 3%, largely mirroring the gains for the S&P 500. But the threat of tariffs could change the market landscape quickly, adding to the uncertainty moving forward.
Higher volatility isn’t a bad thing when it comes to trading. Heavy market movements can open opportunities. That’s especially so in the case of leveraged/inverse ETFs, where traders have the flexibility to play the ups and downs of markets.
Royce Investment Partners added some market insight on how small-caps can respond after heightened volatility. What they found is that, historically, periods of higher volatility seem to precede higher-than-average returns for small-cap stocks.
“We looked at subsequent average annualized returns for the Russell 2000 and the large-cap Russell 1000 following periods when the VIX was elevated, using monthly rolling return ranges for the volatility index,” they noted. “We found that the percentage of periods when the Russell 2000 had higher average annualized 3-year returns than the Russell 1000 were at their highest following periods of heightened volatility.”
Small-Caps Generally Have Strong 3-Year Returns After Periods of High Volatility
Percentage of Trading Days with Moves of 1% or More in the Russell 2000 Over the Last 25 Years, 12/31/99-12/31/24
Stay Flexible With Small-Caps
With potential opportunities ahead in small-caps, traders will want to stay flexible. For bullish moves, the Direxion Daily Small Cap Bull 3X Shares (TNA ) offers triple the exposure to the Russell 2000 index. That allows traders to maximize their profits if small-cap equities continue to show more upside through the rest of the year.
On the opposite end of the spectrum, if small-caps falter in the interim due to market-sensitive news (like tariffs), traders can use the Direxion Daily Small Cap Bear 3X Shares (TZA ). It takes the opposite direction of TNA to give traders more flexibility and tactical exposure to the Russell 2000. And that’s regardless of whether it heads up, or in the case of this particular fund, when it heads down.
Equities of all market cap sizes can always exhibit volatility. So having the ability to trade both bullishness and bearishness will allow traders the ability to profit in any market. This is especially the case with small-caps, which can be subjected to amplified moves in the market.
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