Will the Small Caps Inherit the Market?

While the S&P 500 continued higher in the second half of February, small cap stocks – basis the iShares Russell 2000 Index Fund ETF (NYSE: IWM) – have diverged sharply and are trading well below their mid-February lows. This has created a number of potential short-term opportunities in exchange-traded funds representing these stocks – including and beyond the IWM.

The short-term weakness in small cap stocks is present regardless of whether the stock is small cap growth – the iShares Russell 2000 Growth Index Fund ETF (NYSE: IWO) – or small cap value – the iShares Russell 2000 Value Index Fund ETF (NYSE: IWN). Heading into trading on Monday, both the IWO and IWN have closed lower for five out of the past six trading days and are again trading in oversold territory above the 200-day moving average.

The selling in both ETFs has helped the funds earn “consider buying” ratings of 9 out of 10. Of the two, the growth-oriented ETF has a slightly higher, short-term, positive edge, although both IWO and IWN have edges of approximately half a percent.

Traders looking to make the most of out of the pullback in small cap stocks may want to also consider the short-term oversold conditions in the ProShares Ultra Russell 2000 ETF (NYSE: UWM). Leveraged two-to-one to the Russell 2000 Index, UWM slipped by nearly 3% on Friday, and is now trading at its lowest point in a month.

UWM shares with the other Russell 2000 Index ETFs mentioned above a “consider buying” rating of 9 out of 10. The ETF has a positive edge of more than 1% in the short-term.

The Russell 2000 is not the only source of small cap weakness. The funds representing the smaller stocks of the S&P Small Cap 600 have also retreated to short-term oversold territory, and have earned the kind of top ratings that often signal extreme levels for traders looking to buy weakness in markets trading above their 200-day moving averages.

Two such ETFs – the iShares S&P SmallCap 600/Barra Value Index Fund ETF (NYSE: IJS) and the iShares S&P SmallCap 600 Index Fund ETF (NYSE: IJR) – have already earned top, “consider buying” ratings of 9 out of 10. Relative to the non-leveraged Russell 2000 Index ETFs above, these two S&P SmallCap 600 funds have a modestly higher short-term, positive edges of more than three-quarters of a percent.

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David Penn is Editor in Chief of TradingMarkets.com