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October 05, 2011

Mid Cap Survives Another Month as U.S. Economic Data is Mixed

There are no changes to Northlake's Market Cap and Style models for October. The signals continue to favor Mid Cap and Growth. Underlying indicator movement was modest with a slight shift toward large cap and further movement toward what is now a solid growth signal. With no changes for October, Northlaake clients portfolios will continue to own the S&P 400 Mid Cap (MDY) and the Russell 1000 Growth (IWF) for at least another month.

I am a little surprised that the Market Cap did not shift to large cap for October. The trend indicators did shift reflecting the weak performance of riskier small and mid cap stocks during September's market swoon. However, the economic and interest rate indicators remain mixed, much like the data on the U.S. economy. One of the difficulties for investors in U.S. stocks is that the recession risk is coming from an extension of Europe's problems. U.S. GDP growth has slowed but overall the indicators are not at recession levels. This dichotomy explains why U.S. stocks are so volatile. If recession is avoided, the market looks cheap so any positive news out of Europe causes a big rally, while continued weak economic data and inconsistent communication on contagion response efforts leads to sell offs.

Ideally, the Market Cap indicator remains at Mid Cap as that likely indicates the U.S. avoids recession and the stock market rebounds. I think the outlook is very uncertain and I remain concerned about downside risk. As a result, I am keeping client portfolio positions with much higher cash balances than usual. This protects downside and partially compensates for the added risk while the Market Cap model remains in Mid Cap mode.

Last month, the models put in a poor performance. MDY fell over 10% compared to 7% for the S&P 500. The model did avoid the 12% loss on the Russell 2000 Small Cap index. The Style model's growth signals fared better, with IWF declining just a bit more than the 7% loss on the S&P 500 and falling less than the 8% loss on the comparable value index. For the quarter, the model's performance looks similar. MDY was down significantly more than the S&P but held up better than small caps. The Style model had two months at growth and one at value which produced a return a little worse than the S&P 500.

Disclosure: MDY and IWF are widely held by clients of Northlake Capital Management, LLC including in Steve Birenberg's personal accounts. Steve is sole proprietor of Northlake, an SEC registered investment advisor.

Posted by Steve Birenberg at October 5, 2011 09:29 AM in Models