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August 10, 2006

August 2006 Model Signals

This note was originally written and published on StreetInsight.com on August 2nd. With all the trauma from my the complete crash of my pirmary PC on July 30th, I forgot to post it here. I apologize for my oversight.

There were no changes to the signals from Northlake's market-cap and style models for August. Northlake clients continue to own large cap and value represented by the S&P 500 (SPY) and the iShares Russell 1000 or 3000 Value Index (IWD/IWW). There was some interesting underlying movement in the models, however.

A Decisive Shift in Favor of Large Caps in Market-Cap Model

The market-cap model made a more decisive shift in favor of large caps this month and now sits very firmly in large-cap territory. Not surprisingly, the cause of the further shift is that the trend indicator finally moved in favor of large caps. The lag for this indicator might surprise some folks, especially since small caps initially collapsed in May, but keep in mind that the models are designed to predict relative performance over a six- to 12-month time horizon. I am trying to capture the major trend, not all the wiggles. Consequently, the trend indicators look back six to 18 months.....

Small Caps Could Bounce

There was one contra-trend shift in the market cap model worth noting. The advisory service sentiment indicator moved in favor of small caps due to plunging bullish sentiment. Sentiment dropped far and is now so negative it suggests that bullish behavior will be rewarded. I am glad that the overall model is deeply in large-cap territory, but this indicator may suggest that a dead-cat bounce of relative performance favoring small caps is around the corner.

Style Model Moving Toward Growth

The more interesting results this month were in the style model, which made a fairly strong move toward a growth signal. The model is not at growth yet and might not reach growth, but this is the first move in favor of growth in many months.

Consumer/Cyclical Ratio and Coincident Indicators Shift Toward Growth

Two indicators shifted from value to growth this month: the consumer/cyclical ratio and the coincident indicators. The consumer/cyclical indicator measures the relative performance of the two infamous Morgan Stanley indices. Consumer stocks lifted their heads recently, and maybe a change in well-established, long-term trend favoring cyclicals is at hand. The coincident indicators shifted toward growth because the index is no longer growing on a year-over-year basis. Both of these indicators might be saying that slowing economic growth is the emerging market theme.

Trend Indicators Still Favor Value

These two indicators join relative P/Es, the weak U.S. dollar and tight credit spreads in favoring growth. The complete shift in favor of growth is being held back by the trend indicators, which still favor value.

Trends Favoring Capitalization or Style Persist

One of things I like about my models is that the trend indicators add a timing element that hopefully keeps me from being too early or too late. Again, I am looking for major trends, not monthly wiggles. A look back at market history shows that trends favoring capitalization or style tend to be persistent, often lasting years, and provide large variation in relative performance.

Small Caps Could Bounce

There was one contra-trend shift in the market cap model worth noting. The advisory service sentiment indicator moved in favor of small caps due to plunging bullish sentiment. Sentiment dropped far and is now so negative it suggests that bullish behavior will be rewarded. I am glad that the overall model is deeply in large-cap territory, but this indicator may suggest that a dead-cat bounce of relative performance favoring small caps is around the corner.

Style Model Moving Toward Growth

The more interesting results this month were in the style model, which made a fairly strong move toward a growth signal. The model is not at growth yet and might not reach growth, but this is the first move in favor of growth in many months.

Consumer/Cyclical Ratio and Coincident Indicators Shift Toward Growth

Two indicators shifted from value to growth this month: the consumer/cyclical ratio and the coincident indicators. The consumer/cyclical indicator measures the relative performance of the two infamous Morgan Stanley indices. Consumer stocks lifted their heads recently, and maybe a change in well-established, long-term trend favoring cyclicals is at hand. The coincident indicators shifted toward growth because the index is no longer growing on a year-over-year basis. Both of these indicators might be saying that slowing economic growth is the emerging market theme.

Trend Indicators Still Favor Value

These two indicators join relative P/Es, the weak U.S. dollar and tight credit spreads in favoring growth. The complete shift in favor of growth is being held back by the trend indicators, which still favor value.

Trends Favoring Capitalization or Style Persist

One of things I like about my models is that the trend indicators add a timing element that hopefully keeps me from being too early or too late. Again, I am looking for major trends, not monthly wiggles. A look back at market history shows that trends favoring capitalization or style tend to be persistent, often lasting years, and provide large variation in relative performance.

Posted by Steve Birenberg at August 10, 2006 09:05 AM in Models