Small-cap stocks have been leading the market over the past month, with the iShares Russell 2000 Index ETF (IWM) outperforming the SPDR S&P 500 ETF (SPY) by 4.49% and the PowerShares QQQ Trust ETF (QQQ) by 6.61%. Many analysts attribute this strength to corporate tax reform proposals, since smaller companies tend to pay more taxes than larger multinational companies on the S&P 500 index.

There are a few problem with the small-cap story. Earnings growth is expected to be weak, and small caps are trading at higher-than-average multiples, according to Jefferies analysts interviewed by CNBC. The market is expected to get a more detailed look into corporate tax reform moving into October, but deteriorating fundamentals (at least in the near term) could take a toll. Investors could therefore see a pullback in small-cap stocks. (See also: Russell Breakout Lifts Small Caps Into Leadership.)

Technical chart showing the performance of the iShares Russell 2000 ETF (IWM)

From a technical standpoint, the index broke out from upper trendline resistance on higher-than-average volume in late September. The index has since marched toward R1 resistance at $151.66 before seeing a modest pullback. The relative strength index (RSI) appears extremely lofty at 81.95, but the moving average convergence divergence (MACD) remains in a strong bullish uptrend that has persisted since late August.

Traders should watch for a pullback below R1 resistance at $151.66 over the coming sessions given the lofty RSI reading and impressive run-up since mid-August. A breakdown from trendline support could lead to a move lower to S1 support and 50-day moving average levels at $140.65, while a breakout from R1 resistance could lead to a move to R2 resistance at $155.14 over the coming weeks. Traders will also be keeping an eye on upcoming earnings. (For more, see: A Big Battle Among Small-Cap ETFs.)

Charts courtesy of StockCharts.com. The author holds no position in the stock(s) mentioned except through passively managed index funds.

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