The broad market rally that began March was initially led by small-caps, but a shift has given  large-caps a place in the spotlight. What happened?

• Donna Kardos Yesalavich for The Wall Street Journal reports that small-caps were hit the hardest on the way down, because of the perception they are risky, given their lower liquidity, lack of international exposure and higher trading volatility. (Reasons why both large and small-cap ETFs can round out a portfolio). As a result, small-caps got so cheap that investors snapped them up in droves. The interest drove prices back up to their highest valuations since 1996, putting large-caps back in favor.

• Large-caps may also get a boost from their stability, something investors are still seeking as the markets recover. (Read about the small cap ETF rally here). As a result of the shift, John Spence for The Wall Street Journal notes that the iShares Russell 2000 Index Fund (NYSEArca: IWM) saw $1 billion in outflows in October. It brought in $2.2 billion in the previous three months.

• Profits for smaller companies are also expected to be slower in the fourth quarter, reports Lynn Thomasson and Sapna Maheshwari for Bloomberg. Earnings from small companies are projected to increase 38%, about half as fast as S&P 500 income. (Ways to play a large-cap rally.)

For more stories about asset class ETFs, visit our asset class category.

• SPDR S&P 500 (NYSEArca: SPY): up 23.6% year-to-date

• S&P 500 Growth (NYSEArca: IVW): up 28.3% year-to-date

• S&P Small Cap 600 (NYSEArca: IJR): up 17.7% year-to-date

• S&P Small Cap 600 Growth (NYSEArca: IJT): up 20.2% year-to-date

During the last bear market, small-cap stocks skyrocketed and investors took in 22% a year over the next three  years, remarks Ryan McLimans for MSNBC. Small-caps have a long history of leading the way out of recessions, actually starting their uptrends in the middle of a bear market, rather than after a turnaround. Their small size owes a lot to this, because it makes them more nimble and better able to react to changing market conditions.

There are signs that irrational fear of further economic woes is dampening some small-caps. Yet, some companies have seen impressive net income growth over the last five years. For the unwavering optimists, keep in mind that these small companies could potentially become the next big name brands of tomorrow.

Small-caps tend to be more volatile in the short run. Smaller firms also face more business risks. It is important to be cautious about the “story” or money-making “potential” of small-caps.

This is why using ETFs to gain small-cap exposure is ideal – the provider has done the legwork for you in terms of research on various companies to ensure high quality ones are in the index, and your small-cap risk exposure is lower than it would be with single stocks.

• iShares S&P SmallCap 600 Index (NYSEArca: IJR): up 15.4% year-to-date

• Vanguard Small Cap Value ETF (NYSEArca: VBR): up 20.9% year-to-date

For more information on small-caps, visit our small-cap category.

Max Chen contributed to this article.

Growth ETFs hold stocks that are in growth mode, or are growing faster than the markets.  Value ETFs hold stocks that are “diamonds in the rough” – in other words, they’re undervalued and are being shunned by the market, states Ron Rowland of Money and Markets.

In simple terms, all stocks and ETFs can be considered either value- or growth-oriented, or a combo style known as “blend.” For this reason, it helps to take a look at  market capitalization, as well, to further define styles.  Investors now have more choices: there’s value and growth as well as large-, mid-  or small-cap.

What’s more is that certain categories tend to perform better at some times than at others: small-cap and growth tend to outperform in booming economies; large-cap and value tend to do better in recessionary climates. This isn’t a given, though.

Determining which one to choose is usually up to an investor’s appetite for risk, the type of exposure desired and how diversified one’s portfolio already happens to be.

The SPDR Dow Jones Large Cap Growth (NYSEArca: ELG) is a common choice for large cap growth stocks, whereas the iShares S&P Small Cap 600 (NYSEArca: IJR) is common for value oriented small-cap investors.  Regardless of which way one goes, it is important to have a strategy and mind the trend lines.  For more information on how to watch trend lines, check out our new book.

For more stories on strategy, visit our trend following category.

Kevin Grewal contributed to this article.

Although there are various ways to diversify, Roger Nusbaum, a contributor at TheStreet, follows a Mohammed El-Erian type portfolio with allocations in equity, bonds and real assets. El-Erian is the CEO and co-CIO of PIMCO.

Nusbaum took a look at ETF choices that fit in with El-Erian’s concept:

In the equity portion, he suggests allocating 10% to the PowerShares S&P 500 Buy Write Portfolio (PBP) and 5% to the iShares S&P 600 Small Cap ETF (IJR) which enables investors to benefit from fact that small-cap stocks generally lead the way in the early stages of a stock market cycle.

Additionally, he suggests allocating 10% of a portfolio to the WisdomTree International Large Cap Dividend ETF (DOL) and 5% to the SPDR S&P International Small Cap Index Fund (GWX). In regard to gaining access to emerging markets, Nusbaum suggests looking at the PowerShares BLDRS Emerging Market 50 Index Fund (ADRE).

Next, he suggests adding fixed-income ETFs to a portfolio. In this portion, he states one should look at the iShares Barclays Agency Fund (AGZ) or iShares S&P/Citigroup 1-3 Year International Treas (SHY). PIMCO also offers a PIMCO 1-3 Year U.S. Treasury Index Fund (TUZ).

To wrap up fixed income, he suggests the use of iShares S&P Citigroup International Treasury (IGOV).

In regard to real assets, Nusbaum suggests utilizing the WisdomTree International Real Estate ETF (DRW) the SPDR Gold Trust (GLD) and the PowerShares DB Agriculture Fund (DBA). Additionally, he suggests gaining exposure to infrastructure through the iShares S&P Global Infrastructure Fund (IGF).

Lastly, he states that one should allocate 8% to special opportunities like the PowerShares Water Portfolio (PHO).

In addition to this, we suggest that one utilize a strategy when investing, such as monitoring market trends using the 200-day moving average.  More on the trend following strategy can be found in our new book.

For more stories on portfolio construction and the use of ETFs, visit our ETF education category.

Kevin Grewal contributed to this article.

Russell Investments research indicates that small-cap stocks tend to do well after a recession, indicating their possible outperformance once the market has hit its bottom. This theory has been reinforced since the market lows reached on March 9. Since then, Ian Wyatt for SmallCapInvestor says, the majority of stocks gaining on any particular day have been of the small-cap variety.

Why? Chalk it up to nimbleness. Small-caps can shift and change strategies as market conditions change much more easily than larger companies can.

Meanwhile, the iShares Russell 2000 (IWM) is up 45.9% off the March 9 market low. Traders are watching these indicators, although the jury is still out on whether a turnaround within the market has actually or will occur. Just remember, be ready with an entry and an exit strategy and watch the trend lines, because time will only tell.

Don’t forget about international small-caps, either. Many European small-caps are faring well in a down economy.

• SPDR S&P International Small Cap (GWX): up 14.1% year-to-date

• iShares S&P Small Cap 600 Index Fund (IJR): down 0.1% year-to-date

• Vanguard Small Cap (VB): up 8.1% year-to-date

• WisdomTree Small Cap Dividend Fund (DES): down 7.6% year-to-date

No asset class has been spared in this bear market, but over the long-term, small-cap funds have performed slightly better than their mid- and large-cap brethren. One typically expects small-caps to get pummeled, since they have less diversified revenue resources, are not as globally diversified and have a harder time generating capital, explains Kyle Waller for Seeking Alpha.

Performance has not been consistent, however, as three different ETFs from the same asset class vary widely:

• iShares S&P Small Cap 600 Index (IJR): down 33.7% year-to-date; 19.1% financials; 16.9% industrial materials

• Vanguard Small Cap (VB): down 38.4% year-to-date; 17.3% financials; 16.2% industrial materials

• iShares Russell 2000 Index (IWM): down 35.7% year-to-date; 21.6% financials; 14.5% industrial materials

All three funds are constructed and weighted differently; companies in IJR have to be trading at least 12 months, with four straight profitable quarters and be tested for liquidity before inclusion. VB and IWM have a more passive index methodology approach.

While small-caps haven’t been spared in the turmoil, we expect them to bounce back from a downturn better than most because their small size makes them more nimble and resilient in a market recovery.

To date, the best small-cap sampler is the iShares Russell 2000 (IWM) which has gained 14% for the month ended Aug. 15, almost double of the large-cap tracker SPDR S&P 500 (SPY), according to Dow Jones Newswires.

Many analysts were calling 2008 the year for the large-cap. The small-cap rally defies fundamentals and gives performance chasing-investors a run for their risk tolerance.

Other small-cap ETFs that have hit the market “sweet spot:

• iShares Russell Microcap (IWC): down 9.7% year-to-date; up 5.7% in the last month
• ProShares Ultra Russell 2000 Value (UVT): down 11% year-to-date ; up 12.8% in the last month
• ProShares Ultra Russell 2000 (UWM): down 13.1% year-to-date; up 11.3% in the last month
• iShares S&P Small Cap 600 Index (IJR): down 2.7% year-to-date; up 5.4% in the last month

For full disclosure, some of Tom Lydon’s clients own shares of IJR.

•If history is to repeat itself, is there a small-cap stock and exchange traded fund (ETF) rally on the horizon?

Outperformance by small-cap stocks has generally followed market bottoms of recessions, so says Merrill Lynch. But first we have to figure out if we are even in a recession. Despite this, some investors have already begun placing their bets on stocks of smaller companies, reports Norm Alster for The New York Times.

During the second quarter, small-cap stocks lost 1.6% on average compared to the S&P 500 losing 3.2%, or 4.0% for large-cap value funds. The major weight on small-caps will be the financial sector, which could drag down the performance, as most of the stocks are not cheaply priced.

In an economic recovery, small-caps tend to perform best because they’re nimble and quicker to act when the market conditions are favorable.

Small-cap technology and health-care companies are the main contenders for the small-cap growth stocks that are looking like a better buy than value, according to one strategist. ETFs within the small-cap realm:

• iShares S&P SmallCap 600 Index Fund (IJR), down 9.9% year-to-date
• iShares Russell 2000 Index Fund (IWM), down 10.9% year-to-date
• Vanguard SmallCap (VB), down 11.1% year-to-date