Sizing Up Small-Cap Momentum

Small-cap stocks and the corresponding exchange traded funds have recently been gaining momentum and the momentum factor has been solid all year. The combination of those themes could bode well for more upside for funds such as the PowerShares DWA SmallCap Momentum Portfolio (NASDAQ:DWAS).

DWAS is up nearly 19 percent year-to-date with a significant portion of those gains recently being accrued. DWAS jumped more than 10 percent in the third quarter, making it one of the best-performing factor-based ETFs in the PowerShares stable.

DWAS, which recently turned five years old, follows the Dorsey Wright SmallCap Technical Leaders Index. That benchmark includes securities pursuant to a Dorsey, Wright & Associates, LLC proprietary selection methodology that is designed to identify companies that demonstrate powerful relative strength characteristics based on that companys market performance, according to PowerShares.

A Hot Combination

As DWAS proves, the combination of smaller stocks and the momentum factor is proving rewarding investors. Of course, there are reasons why this is the case.

The best-performing factor combination during the quarter was small-cap momentum, as evidenced by the Dorsey Wright SmallCap Technical Leaders Index, which outperformed the S&P SmallCap 600 Index by 4.62 percent during the quarter, said PowerShares in a recent note. Firming economic growth and renewed prospects for tax cuts supported the overall performance of small-cap stocks, which have the potential to do well in a strengthening economy. Within small-cap momentum, strong stock selection in information technology, consumer discretionary, health care and industrials drove excess returns.

DWAS allocates barely more than a third of its weight to the energy sector, the ETF's smallest sector weight. The $223.2 million ETF holds 200 stocks.

Political Play

Small-cap stocks and ETFs such as DWAS could benefit from some news out of Washington, D.C., including tax reform and a possible interest rate hike in December.

I believe that factor performance in the fourth quarter of 2017 will likely depend on whether or not the Republican-controlled Congress can pass tax reform legislation, said PowerShares. Also key will be continued global expansion, which I believe appears solid, given the September manufacturing Purchasing Managers Index readings in both developed and emerging markets.

DWAS is positioned cyclically as the technology, financial services and industrial sectors combine for over 55 percent of the ETF's weight. Those sector historically perform well when rates rise.

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