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Behind the strange small-cap underperformance

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Trading Nation: Small-cap slap

Small-cap stocks have underperformed large caps lately. The Russell 2000 is down 5.2 percent in the past week and 6.8 percent in the past month, versus declines of 3 percent and 5.3 percent, respectively.

The small-cap lag comes despite a market environment in which smaller companies might be expected to do better. After all, one of the biggest current worries is global growth, and Russell 2000 businesses tend to be more domestic-focused than those in the S&P 500.

But to Boris Schlossberg of BK Asset Management, the recent dive in the Russell reflects market dynamics more than fundamental factors.

Schlossberg argues that due to the prolifation of ETFs, many individual investors who might previously have been invested in individual small-cap stocks are now in large caps instead. That means that swift-moving hedge funds play a greater role in that segment of the equity market.

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"Now that everyone is in (DIA) and (SPY), small caps are left to highly opportunistic hedgies," Schlossberg wrote to CNBC on Tuesday, referring to ETFs tracking the Dow and S&P, respectively.

These funds "exit the trades faster, and leave small caps to rot."

From a technical analysis perspective, Rich Ross of Evercore ISI believes the Russell has recently found an important level of long-term support at its 150-week moving average, which it is currently trading around now.

For Ross, that means the small-cap selling could soon be over.