Over the weekend I received fresh signals from Northlake’s monthly models. The big change for October is a new Value signal in the Style model after four consecutive months signaling Growth. As a result of the new signal, at the open on Monday I swapped all personal and client positions in the Russell 1000 Growth ETF (IWF) and the Russell 2000 Growth ETF (IWO) into the Russell 1000 Value ETF (IWD) and the Russell 2000 Value ETF (IWN). The prior fourth month run of growth signals proved profitable for clients as IWF was sold for a gain of 3.2% and IWO was sold for a gain of 6.2%. During this time period the S&P 500 rose approximately 3.2%….

….Equal amounts of IWD and IWF were purchased matching the equal sized holdings of IWF and IWO which were sold. Implementation of Northlake’s ETF strategy calls for an equal weighted position in large cap and small cap growth or value unless the Market Cap model is sending an unusually strong small cap or large cap signal. In that case, the growth or value holdings will be concentrated depending upon the Market Cap signal.
For October, the market cap model is sending a solid mid cap signal with little change from September. As a result, no changes were made to market cap exposure for October and all personal and client positions in the S&P 400 Mid Cap ETF (MDY) were maintained. This marks the second consecutive month Northlake clients have owned MDY following a switch for September from August’s small cap reading. So far that switch has proved slightly favorable for clients as small gains for MDY have exceeded the gain that would have been earned had positions in small cap been held.
The switch from growth to value for October was driven by three factors in the Style model: widening credit spreads, a flattening yield curve, and a strengthening dollar.
Yield spreads have risen modestly in recent months and are now wide enough to suggest that investors are no longer extremely risk tolerant. Narrow credit spreads are interpreted by the model as favoring growth when investors have a large appetite for risk. The move to value for October coincides with the indication that investors are seeking less risk.
The yield curve has finally flattened enough to move from a growth to a value signal. This factor favors value when spreads are narrower or wider than normal. When the curve is unusually steep business conditions are very favorable which is good for value. On the flip side, buying value when the curve is unusually flat or inverted has paid off in the past presumably because investors are anticipating a near-term easing or cessation of tightening by the Fed. This second condition is what the model is picking up in October.
The recent strength in the dollar leaves it up nicely year-over-year versus other currencies on a trade-weighted basis. A strong dollar favors value because many growth industries get a high proportion of their revenues abroad and suffer when the dollar strengthens.