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For the first time in 13 months, Northlake’s Market Cap model has a new signal. Beginning February, 2012, the model favors small cap. As a result, Northlake client holdings dedicated to the model have sold the S&P 400 Mid Cap (NYSEARCA:MDY) and proceeds were reinvested into the Russell 2000 (NYSEARCA:IWM). There were no changes to the Style model, which continues to strongly favor growth. Positions in the Russell 1000 Growth (NYSEARCA:IWF) will be maintained for at least another month.

As is often the case when the model signal shifts, the new small cap reading is a weak one. Bear in mind that there is often volatility in the signals as they transition so a shift back to mid cap next month is possible. However, barring a significant market setback that impacts the technical indicators, I do not expect that to occur.

The shift to small cap is primarily the result of the same technical indicators. Several months of a strong market rally has been led by small caps. The expanding breadth of the rally generally portends more rallies lie ahead and continued strength for small cap stocks. The model also reflects improving U.S. economic performance. Small caps generally do well in the early stages of economic expansions as investors look to be more aggressive and corporate profits improve.

The expired mid cap signal did not produce excess performance but did not meaningfully lag the market. Over the 13 months, MDY gained 3.7% against an increase of 4.4% for the S&P 500.

Looking just at January 2012, the mid cap signal performed well, with MDY up 6.6% against a gain of 4.5% for the S&P 500. The Style model is also off to a good start in 2012. Growth was up 6.1% last month against 3.9% for value. After struggling in 2011, it is good to see the models on track again.

Disclosure: IWM and IWF are widely held by clients of Northlake Capital Management, LLC. MDY is held in select Northlake client accounts. Steve is sole proprietor of Northlake, an SEC registered investment advisor. IWM is a net short position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, and related technologies. Steve is co-portfolio manager of Entermedia, owns a stake in the funds’ investment management company, and has personal monies invested in the Funds.

Source: Small Caps Are Back In Favor