Northlake’s Market model shifted to small cap for the first time since 2017.  This is the culmination of a gradual move in the model in favor small cap over the last four months.  Client positions following the model will sell holdings in the S&P 400 Mid Cap (MDY) and reinvest the proceeds in the Russell 2000 (IWM).  The Style model continues to recommend growth.  This makes the sixth consecutive month for growth.  Growth has been favored for 16 of the past 19 months with the only the final three months of 2019 maintaining a neutral reading.   The Style model shifts from large cap to small cap exposure only when the Market Cap model is registering small cap.  As a result, clients positions in the Russell 1000 Growth (IWF) and the S&P 500 Growth (SPYG) will be sold and reinvested and in the Russell 2000 Growth (IWO).

Northlake uses a disciplined approach to its models except in extreme market environments.  Thus, even if the model recommendations are inconsistent with other aspects of our market outlook, we complete the recommended trades.  In this case, the shift to small cap in both models aligns well with our views and our desired portfolio structure. 

The market’s advance over the past several years and especially since the February/March 2020 plunge has been driven by a small group of large cap growth stocks.  Apple, Alphabet, and Facebook are Northlake holdings that have pushed the major averages higher.  Microsoft, Netflix, and Amazon are the other large cap growth leaders.  Of course, other stocks have moved up, but these six stocks now compose about 25% of the S&P 500, the most extreme concentration among the largest companies ever.  Correspondingly, the disparity in returns between large cap and small cap stocks has reached historical extremes.  It is Northlake’s view that a period of improved relative performance lies ahead for small caps.  In fact, our Market Cap model shifted from large to mid cap in May and performance has favored mid cap since then by over 2%.

Beyond the extreme historical difference in small vs large cap performance, Northlake’s sees the better than expected economic activity since the economy reopened as favoring small caps.  Small cap stocks usually do best in the early stages of an economic recovery.  The future path for the economy is far from certain due to the recent surge in COVID cases and potentially lingering effects from the economic shutdown.  However, as long as the economy does not turn significantly lower, the set up for small cap stocks is good.

We are pleased to have small cap exposure via our models as we prefer a barbell structure in the current market environment.  On one end of the barbell are large cap growth stocks.  We will still have this exposure through Apple, Alphabet, Facebook, Activision Blizzard and Home Depot.  In addition, small cap growth stocks are well correlated with large cap growth.  The other end of the barbell is small cap value cyclical companies.  The Russell 2000 gives Northlake clients material exposure to this theme.  Nexstar Media Group and ViacomCBS fit in this bucket. In addition, Disney and Comcast have cyclical business segments including theme parks and TV networks.

Small cap stocks typically have a greater risk-reward profile than large cap stocks.  However, at this point in the economic cycle, we believe investors should have diversified exposure across many stock market themes.  This month’s model changes combined with current individual stock holdings leave Northlake client portfolios well diversified and positioned consistently with our broader market and economic views.

IWM and IWO 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.