For the first time in many years, both of Northlake's models changed their recommendations in the same month. For February, the Market model shifted from large cap to mid cap, and the Style model shifted from value to growth. As a result of these changes, all client positions in the S&P 500 (SPY) and the Russell 100 Value (IWD) were swapped into the S&P 400 Mid Cap (MDY) and the Russell 1000 Growth (IWF). Some clients may continue to own SPY as a core holding.
I would not read anything special into the fact that both models shifted in the same month. However, I do think it shows that the fundamental backdrop for the economy (interest rates, GDP growth, trading technicals) is unusual. GDP is growing but only modestly, interest rates have begun to tick higher but remain unusually low, and the stock market continues its steady move upward but with less correlation among individual stocks, economic sectors, and industries than it has had since 2007 before the economic crisis began.
With few economic or stock market statistics registering extremes and correlations declining, the models are not giving off strong signals. This leads to greater volatility on a month to month basis in the signals.
The current shift to Mid Cap was driven primarily by technical trading indicators. The steady rally in the market, which accelerated in January, has been led by small caps, improving the small cap technical indicators, particularly those based on trend. In addition, some weakening in coincident indicators of economic growth amid general growth in the economy has set up a contrarian call to favor small caps. In essence, the market and economic indicators appear to be calling for acceleration in the economic recovery. Historically, this is a good time to own small and mid caps. The Market cap model usually works in stair step fashion with the first step away from large caps to mid caps.
The new growth signal is more a function of relative valuation between growth and value. Growth stocks have really lagged, with technology indices holding back growth. Apple is actually impacting the model as its pullback and the lagging performance in the many stocks that provide products to Apple's supply chain, has been causing technology and growth to underperform the market and value indices. Valuations are now stretched to the point that growth stocks trade at lower price-earnings ratios than value stocks. This is an unusual occurrence as investors normally pay up for growth investments.
The value signal has been in place since the beginning of August. During this time IWD has gained over 13% against a rise of less than 7% for IWF. This large discrepancy in favor of value is a main reason why the valuation indicators shifted to growth, bringing the entire model along. Northlake's Style model made the correct call for the last six months.
The large cap signal emanating from the Market Cap model for the last two months proved less rewarding. SPY tracks the S&P 500, the benchmark U.S. stock market index. This index rose over 5% for the past two months when large cap was favored. Nothing wrong with gaining 5% plus in 60 days! However, both mid cap and small cap indices did better with MDY up 9% and the small cap index (IWM) up almost 8%. The latest signal from Northlake's Market Cap model was inaccurate.
Disclosure: MDY and IWF are widely held by clients of Northlake Capital Management, including in Steve Birenberg's personal accounts. SPY is held by selected clients of Northlake. Steve Birenberg is sole proprietor of Northlake Capital Management, LLC, a registered investment advisor. Regulatory filings can be found at sec.gov.