Each of Northlake’s models has a new signal for May. The Market Cap model is now recommending mid caps after four consecutive months at small cap. The Style model now favors growth after two months at a neutral reading. As a result of the new signals, client positions in the Russell 2000 (IWM) have been sold and proceeds reinvested into the S&P 400 Mid Cap (MDY). We have also sold all client positions in the Russell 2000 Growth (IWO) and the Russell 2000 Value (IWN) and reinvested proceeds into the Russell 1000 Growth (IWF).
The shift in the Market Cap model away from small cap triggers the move out of small cap growth and value into a large cap growth. Northlake only uses small cap in the Style model when the Market Cap model is on a small cap signal. Any time the Market Cap signal is on mid or large cap, the Style model is executed using large cap growth and/or value.
The shift in the Market Cap model to mid cap is a function of changes in the external indicators. Three of the eight external indicators moved from small to large cap for May, leaving six of the right indicators on large cap. The indicators that shifted are related to more modest expectations for economic growth and corporate earnings. Small caps are more sensitive to economic fundamentals given they get more benefit from a favorable economic tailwind.
The Style model saw less overall movement but since it was positioned on neutral and titled toward growth, the movement of just a couple of indicators toward growth was enough to trigger a new signal. The recent decline in the dollar on President Trump’s comments and the French election results is good for growth stocks. Dollar weakness is often interpreted as a sign of weaker domestic GDP, an environment that favors growth stocks that do not need the economy to meet their earnings targets. The other change was to an internal indicator. Growth stocks have done well so far in 2017, driven by large cap internet and technology stocks. This moved one of the trend following indicators to growth from value.
The recently completed signals could have been better. Although small caps made up a lot of ground in April, overall they have lagged in 2017, pulling down the returns in the Market Cap and Style models. In addition, the neutral reading over the past two months for the Style model would have been better in a pure growth.
MDY and IWF are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Northlake’s regulatory filings can be found at www.sec.gov.