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July 02, 2013

Mid Cap and Value Remain the Favored Themes for July

There were no changes to Northlake’s Market Cap and Style model for July. The Market Cap model continues to recommend Mid Cap (MDY) and the Style model still favors Value (IWD). As a result of the new signals, client assets invested with the models will continue to maintain holdings in MDY and IWD.

The indicators underlying the Market Cap model were pretty stable for July. Only trend and technical indicators had new signals including Advisory Service Sentiment, NYSE Breadth, and the momentum indicators.

Advisory Service Sentiment moved from a neutral reading to favoring large cap as the percentage of bulls declined sharply. This indicator is designed to capture trend changes. The recent drop in bulls from an extreme triggered a shift toward the presumably safer large caps.

Another trend indicator, NYSE Breadth also moved in favor large caps. This indicator measures advancing vs. declining issues based on monthly averages. The decline in the market since the mid-May all-time high indicates a degree of caution is warranted. As a result, the less volatile large caps are now favored.

The momentum indicators use shorter time horizons with emphasis on the last six months. Since small caps did pretty well in this period this indicator actually moved in favor of small caps, somewhat balancing out the other trend and technical indicators and leaving the Market Cap signal unchanged at Mid Cap.

There was minimal movement in the Style indicators wit the only change being a shift in the insider activity from value to neutral. This indicator measures insider trading activity among company management and Board of Directors. The value signal that has been in place now for five months has weakened a little but barring a major change I anticipate it holds for at least another month.

With another quarter in the books, it is time to look at the latest quarter and year-to-date performance of the models. Overall, the results are mixed to slightly negative with good results in the Style model unable to overcome poor performance by the Market Cap model.

In the latest quarter, the Style model gained over 3.2% vs. a gain of 2.3% for the S&P 500. The model spent the entire quarter on a value signal, which proved accurate. Year-to-date, the Style model is up over 15.3%, compared 12.6% for the S&P 500. The model has been in value all year except for February when it shifted to growth.

Unfortunately, the Market Cap model was well off target in the second quarter producing a loss of approximately -1.2%. The model favored small cap in April and mid cap in May and June. In each month, the signal was incorrect, favoring the weakest of the three options (small, mid, large). Adding this poor performance to an average result for the Market Cap model in the first, quarter, on a year-to-date basis, the model is lagging the S&P 500, gaining just under 9% vs. the 12.3% gain for the benchmark.

The unusually high volatility in signals emanating from the Market Cap model vs. the stability in the Style model might be instructive. I believe the Market Cap volatility shows confusion in an environment where markets are volatile and economic data are mixed. Both models are constructed using the same theory, so I have every reason to believe that the Market Cap model will prove accurate once again, especially if the slowly improving U.S economy can be maintained as the Federal Reserve begins to back off its most aggressive monetary policy.

MDY and IWD are widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg's personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. Regulatory filings can be found at www.sec.gov.

Posted by Steve Birenberg at July 2, 2013 07:46 AM in Models