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October 01, 2014

Large Caps and Value Remain Favored Themes

There are no changes to the recommendations from Northlake’s Market Cap and Style models for October. The Market Cap model is recommending large caps for the second consecutive month. The Style model is sticking with value, which was first recommended in April. With no changes to the favored themes for October, client portfolios using the models will continue to hold the S&P 500 (SPY) and the Russell 1000 Value (IWD).

The Market Cap signal looks pretty firm at large cap. None of the underlying factors shifted from September to October. Large cap seems like a good place to be with the stock market pulling back in September and lots of issues that are worrying investors. Large cap stocks are less volatile than small cap stocks and should hold up better if a larger correction is underway. Key to performance of the model will be to make a timely move back into mid or small caps to capture the next move up in the market. So far this year, there has been a sharp divergence in the performance of small and large cap stocks. The S&P 500 has gained about 6% through September, while the primary small cap index, the Russell 2000, is down more than 4%. Small caps are not the only volatile sector suffering this year as Emerging Market and non-U.S. Developed market indices are down at least as much the Russell 2000.

Although it is still recommending value, the Style model has undergone a gradual shift toward growth over the past two months. The first shift occurred in August after the current value signal reached its strongest level at the end of July. September saw another shift in favor of value and the model now sits at a spot where a growth signal could occur for November. Recent strength in growth stocks relative to value stocks has shifted the heavily weighted trend indicators to favoring growth. Insider activity has also shifted to growth over the past two months. The only indicator moving toward value has been the U.S. dollar. Dollar strength historically has led to better relative performance for value stocks as growth stocks produce a greater degree of revenues abroad.

As an aside, the strength in the dollar has been one of the issues pressuring the stock market with a lot of programmatic trading set to avoid risk (as in sell stocks) when the dollar is strong. Dollar strength of late is due to a rush to safety from geopolitical issues, the Fed gradually taking its foot off the accelerator when the European Central Bank is easing further, and the emerging weakness in European economies at least partially due to the tense situation with Russia over Ukraine. The Ebola epidemic in Africa could even be supporting the dollar as it is another reason to move to what is perceived as the world’s safe haven security.

The Market Cap model did its job last month as it saved client’s money in a down month. The S&P 500 fell -1.4% last month, holding up much better than -4.7% and -6.1% decline for mid and small caps. The Style model did not fare as well. IWD declined by -2.5% last month, more than the -1.7% decline for the major growth index. Both models have struggled this year, producing appreciation of about 4% vs. more than 6% for the benchmark S&P 500.

SPY 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. Northlake’s regulatory filings can be found at www.sec.gov.

Posted by Steve Birenberg at October 1, 2014 11:34 AM in Models