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January 05, 2010

Back to Mid Cap to Start the New Year

Northlake's Market Cap Model started 2010 with a new signal favoring Mid Cap. This reverses the change made at the start of December when the model moved from mid cap to large cap. As a result of the new signal, positions in the S&P 500 (SPY) linked to the model were swapped to the S&P 400 Mid Cap (MDY). Some clients have long-term, core positions in SPY which are not impacted by shifts in the model. There were no changes to the Style model which remains on a Value signal, as it has since the begging of July.

The shifting signals from the Market Cap model are occurring because the economy and stock market recovery have advanced just far enough to take away the incentive to own higher risk assets that are desirable "when things are so bad, the next move is likely to be up." The model is right on the borderline between moderate risk and below average risk so small changes in the underlying factors can move the needle enough to switch the signal on a more regular basis. In general, average holding periods for both models are four to six months.

The shift to mid cap for January was due to two underlying factors. Market Breadth and Trend Indicators now both favor small cap, creating a situation where half of the underlying indicators are flashing small cap and half are flashing large cap. The resulting signal is mid cap.

Both the factors that changed are reflecting the outstanding performance of small and mid cap stocks in December compared to large caps. Unfortunately, this means that the December shift from mid cap to large cap left money on the table. Clients still made a couple of percent on SPY but had the model stuck with MDY the upside would have been about 5% greater.

The Style model also lagged in December, reversing earlier gains relative to the market and the Growth index. Since the signal switched to Value in July, the resulting investment in Russell 1000 Value (IWD) has matched the market and its growth counterpart.

For all of 2009, both models closely tracked the return on the S&P 500. This is a satisfactory result although the goal of the strategy is produce excess return vs. the S&P 500. Given the highly unusual nature of stock market activity over the past twelve months, it does not seem surprising that in the end returns evened out.

Disclosure: MDY, SPY, and IWD are widely held by clients of Northlake Capital Management, LLC including in Steve Birenberg's personal account.

Posted by Steve Birenberg at January 5, 2010 02:23 PM in Models