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This is a big warning for small caps

Talking Numbers

Small cap stocks have outperformed the large caps. But, are they overvalued?

Large cap stocks are having a good year. But, small cap stocks are having a really good year. In fact, small caps are trading near record highs.

But some traders are saying the top could be in.

While the large cap S&P 500 is up 19.4% in 2013, the small cap Russell 2000 has returned 27.4%. The S&P 500, composed of 500 of the nation's largest companies, is often thought of as the most accurate indicator of the market as a whole. The average market cap for a company in the Russell 2000 is $1.6 billion.

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So why have small caps have outpaced large caps, and are they still cheap?

According to one key metric, price-to-earnings (PE), small caps could be getting a little expensive. Based on data estimates from Thomson Reuters, the Russell 2000 index is trading nearly 21 times its upcoming earnings. Meanwhile, the small cap S&P 600 index trades close to 18 times its forward earnings. If the Russell 2000 were to trade at the same valuation as the S&P 600, then the index would be about 923. That's 15% lower than where it is right now.

Index Last Close Trailing Total Trailing P/E Forward Total Forward P/E
S&P500 1698.06 107.38 15.8 118.94 14.3
S&P400 1253.43 65.48 19.1 75.76 16.5
S&P600 613.29 27.99 21.9 34.45 17.8
Russell 2K 1079.62 38.21 28.3 51.83 20.8
DJ Industrials 15168.01 1077.07 14.1 1185.38 12.8

"Small caps are seen as canaries in the coal mine for an economic recovery," says CNBC contributor Gina Sanchez, founder of Chantico Global. "The challenge is, they are incredibly overvalued. Right now, you're looking at dividend yields somewhere around 1.4% and 1.6% for small and mid-cap stocks. That's a terrible comparison to what you can get even in bonds right now."

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This may also be another case where the charts agree with the fundamentals.

"The technicals support Gina's concerns," says Talking Numbers contributor Richard Ross, Global Technical Strategist at Auerbach Grayson.

What's next for small cap stocks?

Watch the video above to see what Sanchez and Ross think is in store for the Russell 2000 index.

More from Talking Numbers:

Why a 2011-style crash could be coming: BNP
Why Apple can see $630: technician
Roubini: Why I’m bullish on the USA

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