Small-Cap ETFs May Be In Trouble

With U.S. stocks shaking off their third-quarter doldrums and surging to start the fourth quarter, small-caps and the corresponding exchange traded funds are getting in on the act. For example, the iShares Russell 2000 ETF (NYSEArca: IWM) is up 4.3% this month, but that has some market observers the small-cap rally is already at risk of waning.

Investors have been shifting into small-caps as the asset category outperformed larger stocks. If the U.S. economy continues to expand, smaller companies may continue to outperform. In contrast, large-cap benchmarks, like the S&P 500, include more slow-growing multinationals, which may have seen weakened overseas revenue streams after the U.S. dollar strengthened.

Smaller companies are a play on the domestic economy. While previous economic reports have been less than appealing, economists expect the gross domestic product to accelerate in the second half of the year. [Mid-, Small-Cap ETFs to Focus on U.S. Growth]

Global small-cap ETFs are seen as being even more vulnerable than their U.S. rivals. The Vanguard FTSE All World ex-US Small-Cap ETF (NYSEArca: VSS) is up more than 5% this month.

“In the case of VSS, it is interesting to note that the horizontal trendline along with the 200-day moving average have both acted as key levels for traders when setting up their trades. As was discussed above, the level has behaved as many traders would expect by reversing its role when the price moves beyond the identified pivot points. From a risk management perspective, we’d expect active traders to hold a bearish outlook on the VSS fund and many will likely look to protect their short positions by placing stop-loss orders above $98.16,” according to Investopedia.