« Link To Large Cap vs. Small Cap Graphic | Main | More Good News From Central European Media Enterprises »

March 01, 2005

March Model Signals

After trending towards Large Cap for several months, Northlake's Market Cap model triggered a Large Cap signal for March. None of the underlying economic, interest rate, or technical factors individually moved to a large cap signal. Rather, the internal measures used for each factor collectively drifted far enough toward large cap that the trigger was met. The Style model continued its movement toward growth from value but the model remains firmly in value territory. As a result of the new March signals, Northlake initiated a trade for client accounts….

Specifically, all shares of the S&P 400 Mid Cap ETF (MDY) were sold and replaced by shares in the S&P 500 Spyder ETF (SPY). The S&P 500 is the representative large cap index used by Northlake to execute the Market Cap portion of its strategy. SPY and MDY trade within $2 of each other, so client holdings of MDY were swapped one for one into SPY. Some clients with larger cash balances may have purchased additional shares of SPY as part of their unique investment strategy.

The new Large Cap signal did not push deeply into the large cap buy range. Consequently, since the Style model is still flashing value, within the Style portion of client portfolios, no change was made in the 3:1 ratio of investments between the Russell 1000 Large Cap Value ETF (IWD) and the Russell 2000 Small Cap Value ETF (IWN). Nevertheless, some clients with larger cash balances may have purchased shares of IWD or IWN as part of their unique investment strategy resulting in something other than a 3:1 ratio for the time being.

The Market Cap model had been signaling Mid Cap since September 30, 2004. From that date through the end of February, the signal was very accurate as on a price only basis MDY (Mid Cap) returned 12.97%, while SPY (Large Cap) returned 7.94%, and IWM (Russell 2000 -- Small Cap) returned 10.92%. The Mid Cap signal was also accurate for the first two months of 2005 when on a price only basis MDY returned 1.16%, SPY returned -0.20%, and IWM returned -2.49%. Also worth noting is that the five month period during which the Mid Cap signal was in place exactly matched the average holding period in the over 20 year backtest of the Market Cap model.

While I am happy to see that the Market model has worked well since last fall, the signals will not always be so accurate. The goal of Northlake's models is to get it "generally correct." As shown in the 80 year study of large cap vs. small cap performance that was sent to clients on February 22 (link), there are often large and persistent variations in the performance of stocks of different sizes (and styles like growth vs. value). My expectation is not to get it right every month, or every time the signal changes. Rather, I hope the models can get it generally correct and capture a significant portion of the incremental relative performance.

Please remember that the models are a relative , not absolute, performance strategy. The goal is to earn a greater return than the market does when it is rising and lose less when the market fall is falling. If it works, significant excess return can be earned over time periods measured in quarters and years if the market cooperates and produces its historical positive rate of return.

Posted by Steve Birenberg at March 1, 2005 04:53 PM in Models