Small-cap retreat: An ominous sign or no big deal?

NYSE New York Stock Exchange traders markets
Brendan McDermid | Reuters

The U.S. stock market remains in positive terrain for the year after a recent drubbing that pushed the S&P 500 and Nasdaq Composite to five-week lows.

The same can't be said for the Russell 2000 index of smaller companies, now down 3.9 percent on the year, and leading some to question whether its decline is a harbinger of things to come for the broad market.

"The Russell 2000 getting weaker is a point of concern. What the market is dealing with is whether this is a reallocating of assets as we head into the end of the quarter or a fundamental breakdown," said JJ Kinahan, chief strategist at TD Ameritrade.

"The fear is they led the market on the way up and on the way down. But what we're seeing in small caps is more fear-based rather than deteriorating fundamentals," said Nick Raich, CEO of the Earnings Scout.

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Small caps are a "high-beta play, when the market goes up, they go up more," Raich said. "Small caps are selling off sharply relative to large caps, but we're not seeing a slowdown in earnings trends," he said.

"We are by no means in a bubble period as many are suggesting; we're not overvalued, we're not necessarily undervalued," Raich said.

Another veteran market watcher, however, believes the market's rally has come too far, too fast.

"The market might be pricey or overvalued, that's why the decline yesterday and today, and hopefully further," said Hugh Johnson, chairman of Hugh Johnson Advisors.

Johnson points to Federal Reserve Chair Janet Yellen, who in a written report that accompanied two days of testimony to Congress in July, pointed to valuations of social media and biotechnology stocks as "substantially stretched."

"I take Janet Yellen seriously; look at social media stocks or the biotech sector, there are some really good companies in both, but there's no question that some of the valuations are, as she would say, 'stretched.' Look at Twitter, it's crazy, there are areas of the market where valuations are stretched, we could certainly use some pullback in those areas," Johnson said.

Apple is a good example; I bought at $90, and I'd like to buy again, at $90 or lower, but the market is never that accommodating or kind," he added.