Small stocks give back all of their 2017 gains

Sometimes bigger really is better.

So far this year, the S&P 500, which tracks the performance of large U.S. stocks, has surged 8.5 percent. But the small-cap-tracking Russell 2000 is now very slightly lower year to date, after sliding 5.5 percent in the past month to give back all of its 2017 gains.

Chad Morganlander, a portfolio manager at Washington Crossing Advisors, doesn't expect the index to turn around anytime soon.

"We expect overall performance to be subpar until year end," Morganlander wrote to CNBC on Monday. "Valuations need to adjust. Investors should be cautious at this point in time."

Indeed, the current forward price-earnings ratio for the S&P 500 is 17.3 according to FactSet numbers, while the Russell's P/E ratio is above 20.

To be sure, it is typical to see smaller stocks trade at higher valuations, since they are often thought to have more potential earnings upside, and the Russell's valuation premium is in line with recent levels.

But Morganlander's point reflects his general thesis that U.S. equities are vulnerable at this time.

"We're a little more cautious on the overall market and small caps, historically, have a lot more beta than large caps," he said on CNBC's "Trading Nation," referring to a common measure of leverage to overall market moves. The Russell currently has a beta of about 1.15, meaning that if the S&P 500 falls 10 percent, the small-cap index could be expected to drop 11.5 percent.

"We would stick with large-cap growth for the time being" since "it looks as if risk is going to be more elevated over the next three to six months," Morganlander said.

Piper Jaffray technical analyst Craig Johnson agrees that large stocks are the way to go, but for him, the calculus is more straightforward.

"Large-cap stocks are still gaining on a relative basis against mid- and small-caps," Johnson said Monday on "Trading Nation," meaning that the former is outperforming that latter two.

"Because of that, I'm going to stay with the large caps right now," and won't change strategies "until I see a change in relative performance," Johnson added.


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Trading Nation is a multimedia financial news program that shows investors and traders how to use the news of the day to their advantage. This is where experts from across the financial world – including macro strategists, technical analysts, stock-pickers, and traders who specialize in options, currencies, and fixed income – come together to find the best ways to capitalize on recent developments in the market. Trading Nation: Where headlines become opportunities.

Michael Santoli

Michael Santoli joined CNBC in October 2015 as a Senior Markets Commentator, based at the network's Global Headquarters in Englewood Cliffs, N.J.  Santoli brings his extensive markets expertise to CNBC's Business Day programming, with a regular appearance on CNBC's “Closing Bell (M-F, 3PM-5PM ET).   In addition, he contributes to CNBCand CNBC PRO, writing regular articles and creating original digital videos.

Previously, Santoli was a Senior Columnist at Yahoo Finance, where he wrote analysis and commentary on the stock market, corporate news and the economy. He also appeared on Yahoo Finance video programs, where he offered insights on the most important business stories of the day, and was a regular contributor to CNBC and other networks.

Follow Michael Santoli on Twitter @michaelsantoli

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