Sliding Momentum ETFs Stoke Broader Fear

April 11, 2014

But some investors are shrugging off the short-term momentum sell-off.

Momentum stocks and related ETFs have come crashing down to Earth in recent weeks after a huge rally in 2013. While some market observers are giving momentum ETFs the cold shoulder, one investor is taking the pullback in stride and looking to ride the momentum theme long term.

Moment stocks have been hurt by weaker-than-expected economic data in the U.S. and in China, as well as by geopolitical tensions between Russia and Ukraine and ongoing tapering of the Federal Reserve’s quantitative easing in the U.S.

For example, tech and biotech stocks such as Facebook and Gilead Sciences have tumbled in recent weeks, falling 12.6 and 11.8 percent, respectively, in the past month. Last year, Facebook gained 105 percent and Gilead was up 104.5 percent, while the broader market, as measured by the S&P 500 Index, rose 32 percent.

“The momentum factor is prone to sharp pullbacks because investor sentiment shifts disproportionately to changes in the stories behind securities and industries with superior momentum,” said Scott Kubie, chief investment officer of CLS Investments, an ETF strategist shop.

But Kubie hastened to add that his firm is staying the course, and sees no reason to alter CLS’ assessment that the recent momentum-focused decline in stock is anything more than a healthy consolidation in an otherwise-improving economic environment.

PDP_Vs._MTUM_Vs._DWAQ_Vs._PTH_YTD_Performance

Chart courtesy of StockCharts.com

Momentum-Focused Pullback

Specifically, the PowerShares DWA Momentum ETF (PDP | B-56), the iShares MSCI USA Momentum Factor ETF (MTUM | A-59), the PowerShares DWA Nasdaq Momentum Portfolio (DWAQ | B-35), the PowerShares DWA Healthcare Momentum Portfolio (PTH) are down 2.0, 2.5, 4.7 and 6.7 percent, respectively year-to-date.

The S&P 500 Index is currently down 1.8 percent. The selloff continued last week with broader markets in the red again. The S&P dropped another 17.4 points to end Friday at 1815.69 and Nadaq shed more than 54 points to end the session at 3999.73. MTUM is down another 1.0 percent.

Last year, PDP gained 31.7 percent, and MTUM, which launched last April, gained 19.2 percent. Also, DWAQ gained 50.1 percent, and PTH surged 44.7 percent, versus the S&P’s 32.0 percent return.

“With these ETFs, they work if the ‘trend remains your friend,’ said Todd Rosenbluth, director of ETF & Mutual Fund Research at S&P Capital IQ. “But if the market reverses, then they will get hit harder than more diversified ETFs that have a broader mix of what’s hot and what’s not.”

Rosenbluth also noted that momentum-factored ETFs may see more downward price movement in the foreseeable future because, historically, the market has been weakest during the months of May and June.

“S&P Capital IQ has a 12-month target price for the S&P 500 Index of 1,985, but expect that there will be more pullbacks like what we saw in the past week before we get there,” he added.

S&P Capital IQ currently has an overall neutral rating on MTUM and PDP, but is more pessimistic on the PowerShares DWA SmallCap Momentum ETF (DWAS | B-52).

“We have a negative view [on DWAS]. Overall, we view small-cap valuations to be stretched relative to historic levels. In DWAS, we think many of the stocks are overvalued,” said Rosenbluth.

DWAS’ portfolio is currently skewed toward health care names including MEI Pharma, Acadia Pharmaceuticals and Intercept Pharmaceuticals. The ETF is down 7.7 percent year-to-date. Last year, DWAS gained 50.1 percent.

Sector Specifics

Investors using momentum ETFs should pay extra attention to their sector exposure, according to Kubie.

“Currently iShares’ MTUM is overweight healthcare and consumer discretionary,” he said. “If those sectors are less attractive, then you may want to supplement your portfolio with some targeted sector exposure in combination with MTUM.”

Overall, Kubie noted that momentum ETFs are prone to sharp pullbacks because investor sentiment shifts disproportionately to changes in the stories behind securities and industries with superior momentum.

However, he adds that these pullbacks are normal and, based on the current market cycle, his firm continues to stay invested in momentum-themed ETFs because it thinks they will benefit investors over the long run.

 

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