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January 02, 2008

January 2008 Model Signals

Northlake's Market Cap model (courtesy of Ned Davis Research) shifted from a large cap signal to a mid cap signal for January. There was no change in the Style model which continues to flash a growth signal. As a reminder the Market Cap and Style models I use send monthly signals predicting relative performance over an intermediate term time frame which I define as several quarters. The change in the Market Cap model led me to sell positions in the S&P 500 (SPY) and reinvest the proceeds in the S&P 400 Mid Cap (MDY). Northlake's long position in the Russell 1000 Growth (IWF) remains unchanged.

The new mid cap signal is a weak one, just barely moving across the line separating mid cap form large cap. The large cap signal had been in place since last February. It was an exceptionally strong signal from April through September, peaking in August and September at readings matching the strongest large cap signals in the 25 year history of the model. Since September, the large cap model has gradually weakened until it flipped for January.

The Market Cap model measures ten factors based on historical data for small cap and large cap performance. A mid cap signal is flashed if there is spilt decision. Since September when all ten factors lined up for large caps, five of the factors have shifted to small cap camp. These factors are widening credit spreads, rising bearish advisory service sentiment, the steepening of the yield curve, the collapse in consumer confidence, and falling interest rates. Each of these factors now correlates with relative performance favoring small caps.

Turning to the Style model, the reading remains firmly in the growth camp.
The signal is as strong now as it has been since the model shifted to growth in June. There was virtually no movement this month in the underlying indicators....

....During the 11 months the large cap signal was in place, as measured by the ETFs, the S&P 500 rose 1.7%, the S&P 400 Mid Cap rose 2.4%, and the Russell 2000 fell 4.4%. While the Mid Cap was the top performer, I consider the large cap call a win, especially when one adjusts for higher volatility in the mid cap index.

The Style model's call in favor of growth has been a home run so far. Again using the ETFs, the Russell 1000 Growth has gained 2.6% while the Russell 1000 Value is down 7.8%. The large representation of financial stocks in the Russel 100 Value index has really hurt its performance.

I want to reiterate that the new mid cap signal is a weak one and could flip back to large cap next month with little movement in the underlying factors. That said, I always follow my model. No reason to have a model if you aren’t going to follow it.

Posted by Steve Birenberg at January 2, 2008 01:30 PM in Models