By Sue Chang, MarketWatch

Rotation from large caps to small caps is expected to continue

has made the stock market great again with major indexes logging their best performances in months in November. But that frothiness is prompting warnings that the market is getting too bubbly, setting up investors for a disappointment in coming weeks.

The S&P 500 index's forward price-to-earnings ratio, a key metric to measure valuation, has jumped to 16.9 multiples at the end of last week from 16.4 multiples on Nov. 8 while the P/E ratio for the small-cap S&P 600 soared to 19.9 from 17.4 during the same period, said Ed Yardeni, chief investment strategist at Yardeni Research Inc., in a report.

"The valuation multiple for the S&P 600 is now the highest of the current bull market," he said.

The spike in valuation is on the back of $1.2 billion in fresh flows into equities in November, the largest four-week inflow in two years, according to data from Bank of America Merrill Lynch.

And small caps are a big beneficiary as investors rotate out of large-cap growth shares into value stocks in anticipation of Trump's presidency, which Kent Engelke, chief economic strategist at Capitol Securities Management Inc., believes will be "nationalist versus globalist."

See also: Goldman Sachs is the big Dow winner of the Trump rally (http://www.marketwatch.com/story/goldman-sachs-is-the-big-dow-winner-of-the-trump-rally-2016-12-02)

"The odds are high there will be a roll back of some of the more onerous regulations that have stifled small business and small business creation," he said in a note. "Moreover I think monetary velocity will accelerate, an acceleration that will increase economic activity and interest rates, all which will benefit the small companies at the expense of the mega caps."

Nonetheless, Yardeni cautioned that these valuation levels cannot be sustained unless gross domestic product growth picks up to 4% from the current 3% level (http://www.marketwatch.com/story/gdp-rises-at-32-annual-pace-strongest-in-more-than-two-years-2016-11-29) so companies can raise prices in line with inflation.

Jeffrey Saut, chief investment strategist at Raymond James, who has steadfastly maintained his upbeat outlook on the market throughout this topsy-turvy year, agrees that stocks are ripe for a breather.

"The market is very overbought and it will either correct by going sideways or lower," said Saut.

The S&P 500 closed out the week 1% lower while the Nasdaq Composite Index fell 2.7%. But the Dow Jones Industrial Average edged up 0.1% (http://www.marketwatch.com/story/dow-set-to-drop-from-record-high-as-trump-rally-fizzles-2016-12-02) for the week.

"We will likely take a pause and we could have a pullback in the next couple weeks. Corrections are normal and I don't think it will be more than 5%, given that underlying fundamentals are good," said Karyn Cavanaugh, senior market strategist at Voya Financial.

Among the most vulnerable will be financials and industrials sectors, which have witnessed strong gains over the past month. Financial shares have risen 14% while industrials rose 8.5% in November.

See also: Wall Street's Trump optimism comes with heavy dose of uncertainty (http://www.marketwatch.com/story/wall-streets-trump-optimism-comes-with-heavy-dose-of-uncertainty-2016-12-02)

That the correction coincides with a seasonally favorable time for the market when stocks traditionally rally tips the balance in favor of more upside eventually. Since their inception, the Dow industrials have risen in December 71% of the time while the S&P 500 has ended higher 74% of the time, according to Dow Jones data.

It will be a relatively light week for economic indicators although investors will closely track weekly jobless claims on Thursday in the wake of disappointing jobs data this week. The U.S. economy added 178,000 new jobs (http://www.marketwatch.com/story/us-jobless-rates-hits-nine-year-low-of-46-in-november-2016-12-02) in November, falling short of the 200,000 projected in a MarketWatch survey.

It is likewise a lean period for corporate earnings with only a handful of S&P 500 companies slated to release quarterly results. As of Friday, with most companies having turned in third-quarter reports, earnings rose 3.3% while sales grew 5% in the quarter, FactSet data show.

On the international front, the Italian referendum on constitutional changes may have some impact on the market. If voters reject proposed reforms, it could lead to the collapse of Prime Minister Matteo Renzi's government, paving the way for a more populist party to take power.

A "no" vote in Italy, coinciding with a pause in the stock market rally, could trigger more uncertainties, said Saut.

See also: What happens if Italy votes 'no' on Sunday (http://www.marketwatch.com/story/what-happens-if-italy-votes-no-on-sunday-2016-12-01)

(END) Dow Jones Newswires

December 03, 2016 08:00 ET (13:00 GMT)