The Russell 2000 is badly underperforming the S&P 500, and investors are pulling money out of the IWM, the ETF that tracks the index, at a heady clip.
The iShares Russell 2000 ETF saw $1.8 billion worth of redemptions in the week ended May 24th, according to Thomson Reuters Lipper. That made the small-cap tracking ETF the most heavily redeemed in the week, ahead of the much larger SPDR S&P 500 ETF (SPY).
Small-cap stocks "may have had gains late last year in the expectation of benefits of Trump's campaign promises. Those expectations are now waning, along with investors moving out of the asset class," Erin Gibbs, S&P Global portfolio manager, wrote Friday in an email to CNBC.
The index initially surged after the U.S. election in November, rising 16 percent in a month as investors anticipated economic growth and broad corporate tax cuts under the Trump administration that would benefit companies that have mostly domestic revenues.
Expectations for an economic stimulus and protectionist trade policies under the new administration buoyed the Russell 2000, which has stocks that are more domestically focused than does the S&P 500. But with the Trump agenda appearing to founder, the small caps have been left at an inflated valuation compared with their large-cap peers.
Gibbs is also keeping an eye on the Fed. Small companies hold a higher percentage of debt than large ones, which means they run into trouble in periods of fiscal tightening, Gibbs wrote. The Federal Reserve is widely expected to raise its federal funds target rate again in June.
Meanwhile, the lag in small caps appears to be a bit of a warning sign for the larger stocks, said Bill Baruch, iiTrader senior market strategist.
"I don't like to see lagging in the small caps, and I think that can start to signal that the market itself is a little frothy," Baruch said Friday on CNBC's "Power Lunch."
And while he sees stocks continuing to do well through the rest of the year, he does see a correction of 3 to 5 percent in the cards for the S&P 500.
