Shifting to Mid Cap and Sticking With Value to Start the New Year

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

Northlake's Style model shifted back to mid cap for January after a three month run at small cap. As a result, client assets dedicated to the Core and Explore strategy shifted their investment from the Russell 2000 (NYSEARCA:IWM) into the S&P 400 Mid Cap (NYSEARCA:MDY). The Style model was unchanged for January, sticking with the value signal. Client positions in the Russell 1000 Value (NYSEARCA:IWD) will be maintained.

The Market Cap model has been vacillating between small cap and mid cap over the past six months. There is no real message there. Rather, the favoring of small or mid cap over large cap is a sign that the economic recovery is proceeding and interest rates are low. These conditions favor the more volatile asset class with a higher risk-reward tradeoff. For January, there were actually no shifts in the underlying factors making up the Market Cap model. The model uses a two month average and last month the slight uptick in interest rates, which accelerated in December, had moved the one month reading to mid cap. The January update confirmed the prior month reading and shifted the two month average to mid cap.

The Style model has moved back pretty firmly into Value territory after a one month stay at growth in November. I would expect February to once again signal value based on the current readings of the model's underlying factors. The Style model is also signaling a firming economic expansion with conditions that favor continued strengthening. These include low interest rates, a steeper yield curve, and investor appetite for risk. Value is also sensitive to the performance of financial stocks. Banks led the rally in December, pushing the technical and trend indicators that contribute to the Style model deeply in favor of value.

Last month, both model signals proved accurate, capping off a great year for Northlake's models. IWM gained over 7.5%, about 1% more than the S&P 500 and S&P Mid Cap 400. For the year, the Market Cap model returned just over 28% vs. a little under 13% for the S&P 500 on a price only basis.

In December, IWD was also up about 7.5%, beating the S&P 500 by 1% and the Russell 1000 Growth (NYSEARCA:IWF) by almost 2.5%. For 2010, the Style Model earned over 1%, also about 2.5% more than the S&P 500 on a price only basis.

Both of Northlake's models did their job well in 2010. Here is a New Year's wish for more of the same in 2011.

Disclosure: MDY and IWD are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg's personal accounts. IWM is a core holding for select clients of Northlake. Steve is sole proprietor of Northlake, an SEC registered investment advisor. IWM is currently a short position as a hedge against much greater longs in the Entermedia Funds. Steve Birenberg is co-portfolio manager of Entermedia, owns a stake in the Funds' investment management company, and has personal monies invested in the Funds.

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