Changing Market Dynamics and Small-Cap ETF Owners

NEW YORK (ETF Expert) -- For the better part of six months, small-company stocks have outperformed large-company stocks. That's not unusual for an unapologetic bull rally. Indeed, if investors are embracing risk, then they are typically willing to pay a higher price to own faster growing corporations.

Since the beginning of October, however, riskier holdings have been losing momentum to the large-cap bellwethers. The iShares Russell 2000 ( IWM): SPDR S&P 500 Trust ( SPY) price ratio demonstrates the relative weakness in smaller company stock shares.

Courtesy of StockCharts.com

Granted, the major news outlets tend to focus on the Dow, the Nasdaq and the S&P 500. Moreover, many programs enjoy enhanced ratings by covering sexy topics like the Twitter ( TWTR) initial public offering.

Still, it may be a disservice to viewers when talking heads celebrate factoids like, "the market has been up for 17 of the last 20 trading days." Expressing enthusiasm for the Dow in this manner may ignore other facts, like IWM trading at the same price that it did at the start of October.

Courtesy of StockCharts.com

Is it possible that investors are beginning to grow squeamish about small company valuation? Are trailing P/Es of 85 and forward 12-month P/Es of 25 a little too rich for some people's blood? Hard to say. Yet, a continuation of Federal Reserve interest rate manipulation alone does not seem to be reason enough to overweight IWM.

Interestingly enough, the valuation concern is not present in Europe, Australia (Australasia) and the Far East. Consequently, small-cap outperformance has not waned; the iShares MSCI EAFE Small Cap ( SCZ): iShares MSCI EAFE ( EFA) price ratio shows that SCZ is maintaining its relative strength.

Courtesy of StockCharts.com

The under-achievement of small-caps is not the only sign that investors may be turning defensive. The First Trust Equal Weighted Nasdaq 100 ( QQEW) has been giving ground to the SPDR Dow Jones Industrials Fund ( DIA). Ostensibly, investors appear to be backing away from tech-heavy growers and favoring "old school" favorites in the Dow Industrials. The QQEW:DIA price ratio looks ominously similar to the IWM:SPY price ratio.

Courtesy of StockCharts.com

While few people believe the Federal Reserve would enact a surprise tapering in December, some folks may be charting a more defensive course in light of an eventual tapering in 2014. Of course, a lot may come down to the jobs reports that come out over the next few months.

Job growth and wage growth will be the Fed's main justification for backing away from buying U.S. debt at the same pace. Weak jobs reports would likely keep the Fed on hold much longer... and the markets rising with all the complacency that 2013 has represented.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

Disclosure Statement: ETF Expert is a website that makes the world of ETFs easier to understand. Gary Gordon, Pacific Park Financial and/or its clients may hold positions in ETFs, mutual funds and investment assets mentioned. The commentary does not constitute individualized investment advice. The opinions offered are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial or its subsidiaries for advertising at the ETF Expert website. ETF Expert content is created independently of any advertising relationships. You may review additional ETF Expert at the site.

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