Our July 2009 ETF Model Signals a Shift to Value

For the first time since February, there has been a change on Northlake's Core and Explore ETF models. The Style model has moved to Value after spending 5 months at Growth. The new Value signal is weak, just barley in Value territory on Northlake's 0 to 100 scale. However, five of the nine underlying indicators now favor value and a sixth is rated neutral. The trend toward value has been in place for several months so this move comes as little surprise.

As a result of the new signal, all client positions in the Russell 1000 Growth (IWF) were swapped into the Russell 1000 Value (IWD). The effect on client portfolios is to shift exposure from technology, health care and consumer sectors to financial services, utility, and energy sectors. The shift is anticipating a second half recovery in the economy that favorably impacts the more cyclical parts of the economy.

The Growth signal since the beginning of February was very accurate and contributed favorably to client portfolio performance. While clients owned IWF, it gained almost 19% against an increase of less than 12% for the IWD. This is exactly how the model is supposed to function – capturing incremental performance in a major trend.

There was no change to the signal from Northlake's Market Cap model. It remains firmly in small cap territory although the signal has weakened slightly for two consecutive months. The small cap signal also anticipates better times ahead for the economy and continued improvement in credit market conditions.

Small caps, as represented by client exposure to the Russell 2000 (IWM) outperformed the S&P 500 in June for the second consecutive month. SO far in 2009, the Russell 2000 is up 3.6% vs. a gain of 2.5% for the S&P 500. Thus, the Market Cap model has done its job this year. The small cap signal has been in place since September 2008. During that time, small caps have lagged large caps by a little less than 2%. The small cap signal was early in anticipating an improved economic and stock market environment. Performance especially suffered during the initial portion of the market crash in the final quarter of 2008.

Disclosure: IWD and IWM are widely held by clients of Northlake Capital Management including in Steve Birenberg's personal accounts.

Comments

[herbert hoover:]

:.... is anticipating a second half recovery in the economy ...."

Wow, are your clients screwed!

Jul 01 04:11 PM

[whidbey:]

Very interesting, but strange. Does this mean that there is hesitancy in the broad marketplace regarding growth? Obviously it does, but is value second best to cash, or god forbid bonds? In any case, I have started tracking your shift and I thank you but I am heavy cash right now, but expecting a run into August, then a fainting spell.

Jul 01 04:18 PM

[Steve Biren...:]

The Style model shifts solely between growth and value. Assets dedicated to the strategy are fully invested in either IWF or IWD. Cash and bonds are not an option. I do use cash and bonds in other parts of my strategy to meet specific client needs.

It is true that value is a bit riskier if th economy fails to recover but as long as IWD provides a better return than IWF while the model flashes value then it is a win for my this portion of the portfolio.

FYI, the typical holding period for the model is 4 to 6 months but this is a weak signal that could shift back to growth sooner. Weak or strong I do not second guess the model which has a great track record over the last 28 years.

The Market Cap model works the same way -- assets dedicated to it are always fully invested in either small, mid, or large cap represented by IWM, MDY, and SPY, respectively.

Jul 03 08:34 AM

[Gwyn:]

Why is an international asset class not part of the model? Is it because you use large cap as a proxy for international?

Jul 06 05:24 PM

[Steve Biren...:]

Hi Gwyn,

Sorry for the slow reply. I use a separate model got international if a client wants an intl allocation. The intl model is more momentum based and has a lot of volatility from month. More than I like so I use it less often for clients. But basically, I have chosen to focus on being a domestic money manager. Nothing wrong with intl, it is just not my area of expertise.

Steve

Jul 07 11:48 PM

[Gwyn:]

Thanks Steve. You had mentioned in previous posts that a strong small cap bias existed earlier in the year. Have you considered moving your clients "downstream" to a smaller cap ETFs (e.g. IWC) under that scenario to obtain a bit higher return?

Jul 08 08:23 AM

[Steve Biren...:]

I only tested the model using the Russell 2000 so I never considered moving down to microcap. Assuming that IWC correlates highly with IWM I susepct the model would still offer a similar outcome.

I should note that the model still calls for small cap but the signal is not as strong as it was a few months ago.

Jul 08 10:23 PM

[Gwyn:]

The more I read your monthly posts, the more intrigued I become. At the risk of sounding patronizing, I would say you are a genius!
Regarding the “Consumer/Cyclical Ratio” ratio you mention in your June posting:
- Does “Consumer” include both consumer cyclicals and consumer staples?
- Does “Cyclical” include credit cyclicals? Industrial cyclicals? Consumer cyclicals?
- Is there a proxy you use (e.g. ETF, common index, etc) for the “Consumer” and “Cyclical” part of this ratio?

Thanks! Keep up the great work.

Jul 09 08:06 AM

[Steve Biren...:]

Thanks again, Gwyn. I have to admit that the models I use were orginally developed by Ned Davis Research. My contribution is in adapting them to use as a portfolio management tool.

The Consumer Index measure large cap staples: www.analyzeindices.com...

The Cyclical Index has only minimal exposure to financials. It is more weighted toward consumer and industrial cyclical stocks:
www.amex.com/othProd/p...

Keep in mind I use these models for buy and hold money. The idea is that if you have certain monies that will always be invested why not rotate into indices that most make sense in the current environment based on economic, stock market, and interest rate based statistics.

Jul 09 09:14 AM