Fresh signals from Northlake’s Market Cap and Style models are in. The Market Cap signal swung back to Mid Cap for May, while the Style signal remains Growth as it has been since last July. As a result of the new signals, I sold all positions in the S&P 500 (SPY) dedicated to this strategy and used the proceeds to buy the S&P Mid Cap 400 (MDY). I continue to hold client positions in the Russell 1000 Growth (IWF) which is reflection of the Growth signal.
The Market Cap model has been fluctuating between Mid Cap and Large Cap for the last three months. The current signal is a bit stronger in favor of Mid Cap than the one form February. I suspect it will hold for at least another month. The sfit to Mid Cap came about as three of the underling factors moved from large cap to small cap while just one factor flipped the other way. As a reminder, this model is composed of ten factors which I breakdown among economic, interest rate, and technical indicators. Each indicator sends a monthly signal in favor of either small cap or large cap. An overall Mid Cap signals is sent when it is a split decision as is the case for May….

….The indicators that flipped in favor of small cap this month include sentiment, breadth, and coincident indicators. The sentiment indicator is picking up the extreme bearish sentiment reading form a month ago that has now reversed off its low. The breadth indicator is picking up better action in small and mid caps during April. The coincident indicator is making a contrarian call that economic growth has slowed to the point that the next move will be up. That is usually a good time to own small caps.
While the Style model stayed in growth territory, it did show some movement in favor value as one indicator shifted from growth to value. The yield curve has now gotten so unusually steep that it is in a range where value stocks have outperformed. Value has history of outperforming growth when the yield curve is unusually steep or unusually flat.
Last Month’s brief shift from Mid Cap to Large Cap turned out to be a bad call. During April, MDY rose over almost 8% while SPY gained just under 5%. Large Caps did slightly outperform small caps which gained 4.6% as measured by the Russell 1000 ETF (IWM).
The growth signal worked out better in April with IWF gaining a little over 5%, while the Russell 1000 Value (IWD) gained 4.7%. Small cap growth performed even better, gaining 5.8% against 3.9% for small cap value using the Russell 2000 Growth and Value indices, IWO and IWN, respectively. Since the growth signal went into effect in July 2007 it has been very accurate: IWF is down 3% while IWD is down 10.7%. The gap between small cap growth and value is similar.
As always, special thanks to Ned Davis Research who developed these models and continues to maintain them.