ETF INVESTOR: Midcap Stocks Rally Above 2007 High

   By John Spence 
   A DOW JONES COLUMN 
 

For exchange-traded funds that invest in U.S. stocks, the middle seat has been quite comfortable.

The $12.2 billion SPDR S&P MidCap 400 ETF (MDY) recently pushed above its 2007 peak, while funds tracking blue-chip indexes--such as iShares S&P 500 Index Fund (IVV) and SPDR Dow Jones Industrial Average ETF (DIA)--remain below their pre-crisis levels.

For the one-year period ended Feb. 4, the SPDR S&P MidCap 400 ETF was up 38%, outperforming the S&P 500 Index by nearly 12 percentage points.

Small-capitalization portfolios such as iShares Russell 2000 Index Fund (IWM), meanwhile, are approaching their 2007 highs but aren't quite there yet.

"So many investors get caught up in round numbers in the Dow and S&P 500," said Chris Kimble, head of investment-research firm Kimble Charting Solutions.

The Dow's ascent past the key psychological level of 12000 has garnered headlines, while the S&P 500 recently vaulted over the 1300 mark.

Yet the outperformance of U.S. midcap indexes "shows investors need to focus on relative strength," said Kimble, who recommends SPDR S&P MidCap 400 ETF.

"Midcaps look like we didn't even have a crisis in 2008," he said in a telephone interview Tuesday.

Another popular ETF for midcap stocks is iShares Russell Midcap Index Fund (IWR), with more than $6 billion in assets. The target benchmark comprises the 800 smallest stocks in the large-cap Russell 1000 Index.

The average market cap of the ETF's components was $8 billion at the end of 2010. The portfolio's top five holdings were Cummins Inc. (CMI), Priceline.com Inc. (PCLN), NetApp Inc. (NTAP), Weatherford International Ltd. (WFT) and Eaton Corp. (ETN) as of Feb. 7, according to manager BlackRock Inc.

Michael Rawson at research firm Morningstar Inc. said in a recent analyst report on the ETF that midcap shares have historically provided a slight performance premium relative to large-cap stocks.

"Midcap stocks tend to be more volatile because of narrower economic moats and a greater sensitivity to macroeconomic risks, but with this greater volatility comes...the expectation for higher returns," Rawson wrote.

However, the analyst warned that the performance of smaller stocks "can vary drastically over time," while the return premium "has reliably appeared only over periods of a decade or more."

Other ETF options to consider in the space include iShares S&P MidCap 400 Index Fund (IJH), Vanguard Mid Cap ETF (VO) and Vanguard Extended Market ETF (VXF), Rawson said.

(John Spence is a writer for MarketWatch. He can be reached at 415-439-6400 or via email at [e-mail].)