A Make or Break Month for Small-Cap ETFs

December 9th at 2:40pm by Todd Shriber

Soon, January will be here. With that will have observers of seasonal trends and investors in small-cap stocks and exchange traded funds will be eying the start of the January Effect.

That is the scenario where the small-caps lead the broader market higher in the first month of the year, setting stocks up for a strong overall annual performance. There is evidence to suggest that the January Effect has not been commencing in January in recent years, but rather in December and that puts the spotlight on small-cap ETFs right now. [Prep for the January Effect With ETFs]

“December is by far the strongest month for small-caps because the Russell 2000 outperformed the S&P 100 seventy four percent of the time in December. Moreover, December outperformance averaged a whopping +2.4%, which is also the strongest month for outperformance, by far. This study does indeed suggest that the January effect is really in December and the chances are pretty good that small-caps will outperform large-caps this month,” according to Arthur Hill of Chart Watchers.

To that point, small-cap ETFs, including the largest, the iShares Russell 2000 ETF (NYSEArca: IWM), gave investors some cause for concern by slumping during December’s first two trading sessions. However, IWM posted a modest gain through the first week of this month.

The same can be said of the Schwab U.S. Small-Cap ETF (NYSEArca: SCHA) and the PowerShares DWA SmallCap Momentum Portfolio (NYSEArca: DWAS).

Although DWAS holds just 200 stocks compared to the 1,974 held by IWM, an argument can be made that DWAS is an equally important tell regarding the near-term outlook for small-caps. The reason is that the ETF’s focus on relative strength means the fund is highly allocated to momentum sectors, including a combined 47% weight to health care and consumer discretionary small-caps.

The methodology behind DWAS has helped it outpace rival, traditionally-weighted small-cap ETFs this year, another sign that how investors treat DWAS in the near-term could be indicative of their feelings overall toward small-caps. [A Small-Cap ETF for Rising Rates]

Russell 2000 Monthly Performance

Chart Courtesy: Arthur Hill

Tom Lydon’s clients own shares of IWM and SCHA.