Leveraged Small Caps Will Feel Most Pain if Interest Rates Go Parabolic

Inflation across the globe is rampant according to the ongoing macro publications. The areas of special concern are energy, grains and food prices. U.S. Federal Reserve Chair Jerome Powell said the central bank is prepared to raise interest rates by a half percentage point at its next meeting if the situation remains stark. The Fed is apparently deploying a more aggressive tone toward curbing inflation than he used just a few days earlier. Verbally, nothing is stopping policymakers from hiking by a half-point in May. Powell added that such a decision had not been made, but acknowledged it was possible if warranted by incoming data.

Jerome Powell's aggressive tone sent bond markets into a tailspin and shifted investors’ attention on the various recession signals they have been throwing up. The spread between five-year and 30-year Treasuries slumped to its smallest since 2007 as the yield curve strongly tilted towards an inversion. If interest rates are to be increased at a robust pace, then the most heavily indebted companies will suffer sooner rather than later. The Small Cap Russell2000 Index comprises the highest share of highly leveraged companies among its peers.

With assets under management (AUM) of $338 million, the ProShares Short Russell2000 (RWM) offers inverse exposure to an index comprised of small cap U.S. equities as chosen by Russell, making it a potentially attractive option for investors looking to bet against this highly leveraged sector of the U.S. economy. Financials command the top index sector weighting at 17.63%, followed by healthcare at 15.85% and information technology at 15.39%. The 13-year-old fund turns over more than 500,000 shares per day on an average spread of just 0.02%, making it a suitable instrument for traders who make tactical bets against small-cap stocks. RWM's 0.95% expense ratio isn't exactly cheap but remains competitive for an ETF that provides inverse exposure.

RWM trended lower throughout January and February delivering a -3.73% return but during the past quarter rose slightly above 1%. Currently it is priced at $22.09 apiece. Those who buy the pullback should consider setting a take-profit order near the pattern's top trendline at around $33 level and implement risk management by cutting losses if the price fails to hold above the 52-week low at $19.26 and raising stop orders to the breakeven point on a rally above the 200-day simple moving average (SMA).