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August 03, 2009

August 2009 Model Signals Favor Small Caps and Value

There were no changes to Northlake's monthly Market Cap and Style models for August. The Market Cap model is still recommending small caps and the Style model is signaling Value. The small cap signal has been in place since September 2008, while this is the second consecutive month for the value signal. As a result of the fresh signals, Northlake clients will continue to own positions in the Russell 2000 Small Cap index (IWM) and the Russell 1000 Value index (IWD).

Two of the underlying indicators in the Market Cap flipped this month but the overall signal strength is unchanged at a moderately strong reading in favor of small caps. Seven of the ten indicators are flashing small cap.

The Advisory Service Sentiment indicator moved from small cap to large cap for August reflecting rising bullish sentiment. This indicator is contrarian, moving into small caps when bearish sentiment is rising rapidly and into large caps when bullish sentiment is rising rapidly (presently the case). The idea is to anticipate the next move in sentiment. When everyone is bearish, it means they have already sold and the next market move is likely up. Small caps are favored for the extra volatility they provide on the way up. That same volatility is a penalty if bullish sentiment is too strong signaling a market correction. Thus, at bullish extremes the move is back to less volatile large caps.

The other Market Cap indicator to change this month is Consumer Confidence, which moved to a small cap signal. This indicator is picking up a bottoming in consumer confidence measures which suggests better times ahead. Better times means investors want the extra bang provided by small cap stocks.

There were no changes to the underlying indicators in the Style model for August. The reading remains fairly weak although due to use of two month smoothing to reduce volatility of the signals, the August signal is slightly stronger than the July signal.

The models performed well last month, continuing a recent trend of accurate signals. IWM gained 8.8% in July, comfortably ahead of the 7.4% gain in the S&P 500. So far this year, the Market Cap model has produced a return of 12.9% against a rise of 9.3% for the S&P 500. The recent run of accurate small cap signals has regained most of the lost performance from September through March when the small cap signal proved early. Since last September, IWM is -24.8% against -23.3% for the S&P 500 as measured by SPY.

The Value signal almost matched the S&P 500 last month gaining 7.1% against the S&P 500's 7.4%. Value started July poorly but gained through month end and led the way on August 3rd as the S&P 500 continued its rally and broke through 1,000 for the first time since early November 2008.

Disclosure: IWM and IWD are widely held by clients of Northlake Capital Management, LLC including in Steve Birenberg's personal accounts. SPY is held as a core or trading holding in many Northlake client accounts once again including Steve's personal accounts.

Posted by Steve Birenberg at August 3, 2009 02:20 PM in Models