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September 04, 2012

Large Cap Favored for First Time Since 2009

After five months favoring Mid Cap, Northlake’s Market Cap model switched to a Large Cap signal for September. As a result of the switch, client positions in the S&P 400 Mid Cap (MDY) have been sold and the proceeds reinvested into the S&P 500 (SPY). The Style model is recommending Value for the second consecutive month. All Northlake client positions in the Russell 1000 Value (IWD) will be maintained. This is the first time the Market Cap model has recommended large cap since 2009.

The shift to large cap has been underway over the past few months as the economy has cooled and investors have been looking to reduce risk. Small cap stocks lagged the summer rally, shifting the technical trend indicators in the model to large cap. Rising interest rates, albeit still at extremely low levels, was the tipping point that led to the switch to large cap. Rates are up modestly since the European Central Bank indicated it would aggressively buy European sovereign debt to ease the funding crisis in Spain and Italy. Rising interest rates hurt small companies more than large companies as multinational corporations generally have easier access to credit.

The latest monthly signal is pretty firmly into large cap territory so I expect this change to hold for a while. Given the fragile nature of the global economy, still significant risk in Europe, the upcoming U.S. election, and the “fiscal cliff,” I am comfortable with a shift to large caps, which are usually less volatile and hold up better in weaker market environments. I am not predicting a weak market but I do not mind carrying less risk into the fall given the many looming issues.

The value signal issued by the Style model last month for the first time remains borderline. Two more indicators shifted toward value for September, insider activity and relative valuation. I still see the shift from growth to value as a relative valuation call. Growth has outperformed value this year and while the economy is weak, it is still growing. An economic tailwind is good for value stocks. It appears that value stocks are finally cheap enough to warrant investment.

The recently expired Mid Cap signal proved inaccurate. Since it went into place on April 1st, MDY returned -5.23% against -2.20% for the S&P 500. As noted above, small and mid cap stocks lagged the summer rally. Small and mid cap stocks usually lead rallies. The action this summer reveals how wary investors remain even as the market has risen.

The first month of the new value signal also was off target. IWD did rise 1.94%, matching the S&P 500 during August. However, growth led the way in August with the Russell 1000 Growth (IWF) rising 2.88%. Apple and Google rose sharply in August, leading growth stocks higher. Fortunately, both of these stocks are in Northlake’s individual stock portfolio.

Disclosure: SPY, IWD, AAPL, and GOOG are widely held by clients of Northlake Capital Management, LLC. MDY is held in select Northlake client accounts. Steve is sole proprietor of Northlake, an Illinois-registered investment advisor. Filings can be found at www.sec.gov. AAPL and GOOG are net long positions in the Entermedia Funds. SPY is a net short position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, and related technologies. Steve is co-portfolio manager of Entermedia, owns a stake in the funds’ investment management company, and has personal monies invested in the Funds.

Posted by Steve Birenberg at September 4, 2012 11:20 AM in Models