Over the past several trading sessions, we’ve seen a rotation of sorts from defensive sectors and into cyclical sectors. The Russell 2000 Index and the NASDAQ were the two best-performing major indices yesterday, while the Dow lagged. Among sectors, we saw a lot of basic materials-related stocks do well, including homebuilders and consumer discretionary. Conversely, traditional safety sectors like utilities, healthcare, and consumer staples lagged.
The nascent rotation away from defensive stocks, which so far have led the 2013 rally, and into cyclical sectors just might be the first real leading indicator we have that the improved metrics in the U.S. and global economy are starting to take hold. I say might be, because there are still many global and domestic economic headwinds that have to calm before we can bet confidently on the global growth story.
Still, part of being a good trader is “seeing the writing on the wall” as it were, or stated differently, sometimes the biggest money is made getting long a sector when it’s just starting to see the influx of rotational money.
As previously mentioned, the Russell 2000 Index has outperformed larger-cap indices. If this trend continues, ETFs pegged to the small-cap, cyclical segment could indeed make traders some real money.
The best ETF to take advantage of this is the iShares Russell 2000 (NYSE:IWM). This fund seeks performance results equal to that of its underlying small-cap index. The chart here of IWM shows the early April pullback in the fund, followed by the recent rebound that’s taken IWM back above its 50-day moving average.
For the more intrepid profit seeker, a high-risk, high-reward way to play the rebound in cyclical small caps is the Ultra Russell 2000 (NYSE:UWM). This leveraged fund is designed to deliver twice the performance of the Russell 2000. So, if the Russell gains 2%, then UWM should jump 4%.
Click to Enlarge The leverage in UWM allows the gains in the fund to be bigger, but it also means there’s the real possibility of more downside for traders. As you can see here, in midday-Friday trade, IWM was down 0.90% while UWM had fallen 1.83%. The added leverage and increased volatility here is great when it’s in your favor, but just keep in mind that there’s far more downside risk in the leveraged variety.
For traders looking to play this latest sector rotation, IWM and UWM represent two of the easiest ways to get exposure to this thesis. I suspect that we could see another 10% upside in IWM over the next several months, and that would likely translate into a 20% gain for UWM.
Just remember that if we’re wrong about this thesis, the best way to protect yourself is to make sure you have a stop-loss in place anywhere between 8%-12% below your official buy price.
At the time of publication, Jim Woods did not hold a position in any of the stocks mentioned here.