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November 02, 2009

November Model Update: Mid Cap and Value Still Favored

There are no changes to Northlake's Market Cap and Style models for November. The Market Cap model is sending a Mid Cap signal for the second consecutive week. The Style model has a Value reading for the fifth consecutive month.

Underlying trends in the Market Cap model show a continued shift toward large cap and away from small cap. However, while leaning toward large cap, the indicators remain mixed, so the signal remains on mid cap. Two indicators moved in favor of large caps this month. Both were technical/trend indicators, reflecting the weak performance of small cap stocks last month. More detail can be found be below.

The Style model also saw two changes to underlying indicators this month, one in each direction. The valuation indicator switched from growth to value as value stock relative P-E ratios are now below average compared to growth stocks. This reflects the economic recovery and the positive impact it has on value companies that tend to be more sensitive to economic growth.

The trend indicators moved from value to growth last month. This reflects a good month for growth stocks in October. More details below on this as well.

Overall, the Market Cap ad Style models still reflect an improving economy and better investor confidence that the recovery will take hold. The models are no longer at the extreme readings from earlier this year when investor sentiment was very sour and the economy was at the depths of the recession. The result is that the models are sending somewhat mixed readings that no longer advocate for the most aggressive positioning. Client positions in the S&P 400 Mid Cap (MDY) and Russell 1000 Value (IWD) are being maintained and reflect the mixed readings.

Northlake's models were off target in October but not all was lost. The Market Cap model moved from small cap in September to mid cap for October. This proved to be a mixed signal as the Russell 2000 (IWM) fell by 6.5% against a decline of 4.5% for the S&P 400 Mid Cap (MDY). However, mid caps still underperformed the large cap S&P 500 (SPY) in October. SPY fell just 2.0%. The Market Cap model correctly called moving away from small caps after a 13 month run but incorrectly shifted only to mid cap.

The Style model's four month run on value still looks good. Value, as measured by the Russell 1000 Value index (IWD) has outperformed growth, as measured by the Russell 100 Growth index (IWF), by more than 1%. However, in October growth was the winner, limiting its loss to -1.3% vs. -3.2% for the S&P 500.

Mid caps and value lagged in October due to souring investor sentiment toward the economic recovery. Both strategies work better in a bullish stock market environment. The S&P 400 Mid Cap benefits from greater volatility relative to large caps and also has more exposure to economically sensitive industries like materials and energy. The Russell 1000 Value has a similarly greater exposure to economic trends with the addition of many more financial companies. Financial companies are the fulcrum of investor sentiment this market cycle due to their central role in the economic crisis.

Disclosure: MDY and IWD are widely held by clients of Northlake Capital Management, LLC. IWM and SPY are held by certain clients of Northlake as core positions. In his personal accounts, Steve Birenberg holds MDY, IWD, and SPY.

Posted by Steve Birenberg at November 2, 2009 10:07 AM in Models