Who’s Afraid of Small Cap Stocks Now? Apparently Equity Investors (IWM, IWN & IWO)

Any small cap investor who has been paying attention to the iShares Russell 2000 Index ETF (NYSEARCA: IWM), the iShares Russell 2000 Value Index ETF (NYSEARCA: IWN) and the iShares Russell 2000 Growth Index ETF (NYSEARCA: IWO), three ETFs that track the Russell 2000 small cap index, would have noticed that all three have given a stellar performance since the start of the year. In fact, the iShares Russell 2000 Index ETF (IWM) is up 12.2%, the iShares Russell 2000 Value Index ETF (IWN) is up 11.27% and the iShares Russell 2000 Growth Index ETF (IWO) is up 12.74%. In contrast, the iShares S&P 500 Index ETF(NYSEARCA: IVV) is up only 7.07% since the start of the year.

However and not to throw cold water on any investor or trader�s enthusiasm, here is a startling fact that could scare you: Retail fund flows from small cap stocks have recorded outflows in 36 of the past 39 weeks. Let�s repeat that: More money is leaving small cap stocks than is being invest in them.

That fact was brought up in a research note by Bhupinder Singh, a small-cap equity strategist at J.P. Morgan Securities (and noted in a Wall Street Journal blog), who has long been beating the drum for small cap stocks � even when they were heading down last year. Bhupinder Singh went on to note that the stock market has completely reversed itself with volatility �collapsing,� yields on European debt falling and a global rally for equities and yet equity investors �still remain unenthused.�

In regard to the outflows ($17.8 billion), Bhupinder Singh noted that outflows on this scale are more typical of a recession � not an economic recovery. He also noted that J.P. Morgan�s in-house surveys show �anything but enthusiastic� for the current rally.

So what gives for small cap investors or traders? Certainly anyone sitting on-top of large gains for the iShares Russell 2000 Index ETF (IWM), the iShares Russell 2000 Value Index ETF (IWN) and the iShares Russell 2000 Growth Index ETF (IWO) might want to consider pairing back a bit but then again and if the rally continues, retail investors are likely to start jumping back in as usual (and as usual, usually at the top right before the pullback).

Otherwise, my take would be that investors who have missed the rally so far should avoid the iShares Russell 2000 Index ETF (IWM), the iShares Russell 2000 Value Index ETF (IWN) and the iShares Russell 2000 Growth Index ETF (IWO) and instead focus on finding quality small cap stocks as these catch-all ETFs tracking indices like the Russell 2000 small cap index tend to get plenty of good and bad stocks thrown together and move up and down on market momentum. After all and should the market suddenly reverse course again on the never ending European debt saga, another debt ceiling or related political fight or another black swan event (earthquakes, tsunamis, nuclear meltdowns and you name it�), you don�t want to be caught in a down draft that might rout IWM, IWN and IWO.