Back to Value as Economic Recovery Becomes More Sustainable

Includes: IWD, IWF, IWM
by: Steve Birenberg, CFA

Northlake's Style model shifted back to Value after a one month stay at Growth. The model is in transition with mixed signals that are straddling the line between growth and value. The monthly signal volatility is not unusual when a long running signal reaches its conclusion. Prior to last month, the Style model had been signaling value since the summer of 2009. I think the trend is clear and I expect a growth signal to re-emerge over the next few months. But I never outguess the models so as a result of the new signal, all Northlake client holdings in the Russell 1000 Growth Index (NYSEARCA:IWF) have been swapped back into the Russell 1000 Value Index (NYSEARCA:IWD).

The shift this month occurred primarily due the recent strength in the dollar. Growth stocks benefit from a weak dollar as many growth companies like technology and pharmaceuticals do much of their business outside the United States. With the prior month's growth signal being a weak one, right on the border between growth and value, one factor shifting its signal was enough to change the Style model's recommendation. Regardless of the volatility of the signals of late, the message from the Style model is that the economic recovery is moving from its cyclical bounce to a more sustainable, albeit low growth phase. This phase of the economic cycle favors growth because these companies can sustain momentum with less help from the economy than the cyclical companies that dominate value indices.

The Market Cap model remains on a small cap signals for the third straight month. As a result, client holdings in the Russell 2000 (NYSEARCA:IWM) will be held for another month. The Market Cap model did have underlying movement toward large cap. In fact, there is a good chance that next month the signal will shift to mid cap. Weaker market breadth in November, still modest levels of consumer confidence, and recently rising interest rates all contribute to the weaker small cap signal this month.

Last month both model signals provided value added. The growth signal generated a positive return of almost 1%, while value and the S&P 500 each produced a small negative return. The small cap signal was particularly good in November as the Russell 2000 (IWM) gained almost 3.5% a little higher than mid cap and much higher than the small loss for the S&P 500. Year-to-date, the Market Cap model has been extremely valuable, producing a return of 15% against just under 6% for the S&P 500. The Style model has mixed results, producing a gain about 1% ahead of the S&P 500.

Disclosure: IWD and IWM are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg's personal accounts. Steve is sole proprietor of Northlake, an SEC-registered investment advisor.