Playing Momentum with ETFs (PDP, PIE, MTUM)

Investing based on momentum and relative strength has been a successful strategy the last few years as the market hit new all-time highs several times. A recent pullback in the stock market due to the government shutdown has brought the ETFs that following the concentrated strategy back to support levels. Keep in mind that even momentum ETFs will not move higher every day and that pullbacks are part of a long-term bull market.

PowerShares DWA Momentum Portfolio ETF PDP

The ETF is up 21 percent in 2013 and is trading 1 percent below an all-time high. The ETF is based on the Dorsey Wright Technical Leaders Index and is composed of approximately 100 mid-cap and large-cap U.S. stocks. The index is based on a proprietary methodology that takes into stock account performance versus a benchmark as well as the relative performance of industry and sub-sectors. The universe begins with 3,000 of the largest U.S. stocks. Since 2007 the index has outperformed the S&P 500 and trades more inline with the S&P 500 Growth Index. The top holdings currently include tech darlings priceline.com PCLN and Apple AAPL.

iShares MSCI USA Momentum Factor ETF MTUM

Launched in April of this year, MTUM has lagged PDP since its inception most likely due to a difference in how stocks are chosen for inclusion. The ETF is currently made up of 123 large-cap and mid-cap stocks based in the U.S. The portfolio is reallocated every quarter based on a formula that attempts to identify stock exhibiting relatively higher momentum characteristics. The ETF is heavily weighted in the health care and consumer staples sectors, which are not often viewed as momentum plays. The top two holdings are Johnson & Johnson JNJ and Gilead Sciences GILD.

PowerShares DWA Emerging Markets Momentum Portfolio ETF PIE

Similar to PDP, this ETF tracks a Dorsey Wright Index, except the difference is that it only concentrates on stocks based in emerging market countries. Since the beginning of 2008 the ETF has lagged the S&P 500 as well as the MSCI Emerging Markets Index. This is due to the emerging markets not enjoying the same bull market as the U.S. stocks. The ETF is diversified over several sectors and is most heavily weighted in Taiwan and China. Year-to-date the ETF is up less than 1 percent, but has been able to rally 15 percent from the late August low as the emerging markets are beginning to attract new buyers.

The emerging markets momentum ETF is a perfect example of how this type of strategy tends to underperform in a non-bull market. That being said, the U.S. appears to be in the middle of a long-term bull market that should continue to see the momentum stocks outperform.