Our September Model Still Favors Small Caps, Value

There were no changes to Northlake's Market Cap and Style models for September. The signals remain small cap and value. As a result, all client positions in the Russell 2000 (IWM) and Russell 1000 Value (IWD) controlled by these models will remain in place until at least the first trading day of October.

August marks the 12th straight month that the Market Cap model has sent a small cap signal. September's signal weakened for the third straight month and could easily switch to mid cap for October. The Market Cap model generally follows a stair step approach as it moves from small to mid to large and in reverse.

Small Cap Signals Weakens

The weaker small cap signal for September came about as a result of an apparent peaking of bullish sentiment, the rebound in consumer confidence, and newly neutral trend indicators. The Market Cap model is designed to put money into small caps when the economy looks bleakest and bearish sentiment is high. With increasing signs the economy has emerged from recession and the huge rebound in stocks since the March low, a weaker signal or a shift away from small caps is logical.

The small cap signal has worked well recently. Since the end of March, the model has produced a return of 36.0% vs. a gain of 28.8% for the S&P 500 ETF (SPY). Year-to-date, the model is up 16.2% vs. 13.5% for SPY. As discussed in prior emails and quarterly letters, the shift to small caps was early this cycle due to the very fast deterioration in the economy last summer and fall and last September's market crash. As a result, since the small cap signal has been in place, the model has produced a return of -22.6% vs. -20.4% for SPY. Obviously, the bulks of the lagging performance occurred in 2008 from September through December.

Weak Value Signal Remains

There was minimal change in the Value signal for September. The model continues to flash a weak value signal with the only underlying indicator showing any movement being the trend indicators which moved from neutral to value. The Style model continues to pick up a bottoming in economic activity and signs of renewed economic growth. Value stocks ate typically more cyclical and make sense at this stage of the economic cycle.

The shift in the trend indicator reflects a very strong month for value stocks in August. The Russell 1000 Value gained 5.4% against just 1.9% for the Russell 1000 Growth. Improved sentiment towards an economic recovery and huge rebound in financial stocks helped value outperform. The current value signal came into place at the start of July and so far it has produced a return of 12.9% vs. 8.8 % for the corresponding growth index and 11.0% for SPY.

Comments

[whidbey:]

Thanks. The value seems the best play if we get a blow off top in the indexes into the fall, i.e. 11500 Dow etc.

Why no interest in Gold? or Silver? Are bonds a part of your portfolio advice?

Seems interesting, but rather incomplete in a tired market.

Sep 03 08:23 PM

[Robert Mart...:]

Steve,

Kudos on sticking to your guns with the shift to small-caps.

You noted: "The Market Cap model is designed to put money into small caps when the economy looks bleakest and bearish sentiment is high." That's easier said than done, since it was gutsy to overweight small-caps in the Spring.

On another note, does the Market Cap model consider export exposure? Large-caps have a much higher % of sales overseas, and will benefit from a rebound in Asia ex-Japan. Perhaps you account for this by using something other than the Market Cap model.

I note with interest that the Style Model is flashing only a "weak" signal. That's consistent with the mixed economic recovery now underway in the U.S., given a jobless recovery amidst rampant outsourcing. Corporate profits have disconnected from American workers, which I discussed this at length in "The Deflation of the American Dream". seekingalpha.com/artic...

Have a great weekend,
Rob

Sep 04 09:21 AM

[Steve Biren...:]

Whidbey,

My strategy for clients is pretty much 100% stocks. I use these models to guide about 75% of the investments. The ret is in media and communications stocks, which are my specialty. Nothing wrong with gold, silver, and bonds, just not what I do. My clients know what they are getting from me so it is not a problem to have a more narrow strategy.


On Sep 03 08:23 PM whidbey wrote:

> Thanks. The value seems the best play if we get a blow off top in
> the indexes into the fall, i.e. 11500 Dow etc.
>
> Why no interest in Gold? or Silver? Are bonds a part of your portfolio
> advice?
>
> Seems interesting, but rather incomplete in a tired market.

Sep 04 01:23 PM

[Steve Biren...:]

Rob,

One of the advantages of using models is that they make the decisions for you, often when it is the toughest call. Obviously, your model needs to be well designed and regularly monitored to make sure it remains valid.

The Market Cap model includes a US dollar indicator based on 12 month rate of change. Right now the dollar is weaker on that basis and thus that indicator favors small caps. However, it may flip shortly as the 12 month rate of change has been moving toward strength.

I agree that the weak signal in favor of Value reflects a mixed economic outlook.

Sep 04 01:28 PM