There are no changes to Northlake’s favored themes for December.  We remain neutral on growth versus value and continue to favor mid caps.  As a result, current client positions following the models in the Russell 1000 Growth (IWF), the Russell 1000 Value (IWD), and the S&P 400 Mid Cap (MDY) will be held for at least one more month.

Our recent monthly updates have discussed our view on what Wall Street is referring to as the “rotation trade.”  At Northlake, we believe the rotation trade has legs well into 2021 and our models have positioned clients to benefit by owning value and mid cap.  There are several aspects to the rotation.  First, large cap growth stocks have massively outperformed, while all value stocks have been left behind.  Relative performance between growth versus value and large versus small/mid cap is well above even past historical extremes.  Think about stocks like Apple, Facebook, and Alphabet as leading examples of large cap growth.  Second, the pandemic exacerbated the performance gap between large versus small and growth versus value by creating COVID winners and COVID losers.  Large cap growth companies are largely winners in a work from home environment.  COVID losers include many companies in cyclical industries such as hospitality and entertainment.  Losers also include naturally cyclical economic sectors such as finance, energy, and industrials.  A recession is bad news for companies in these sectors under almost any circumstance.

The rotation trade is a shift in leadership from large cap growth stocks to small and mid cap value and COVID losers.  The rotation started in late summer and accelerated when initial Phase 3 trial results for leading vaccines were encouraging.  Northlake expects pent up demand in cyclical industries and COVID loser businesses.  As long as vaccines can be widely distributed in 2021 and prove as effective as they have been in trials, we think the recent outperformance of value, small and mid cap, and COVID losers has a long way to go.  Just getting back to near historical relationships provides a long runway.

Northlake’s models picked up on the rotation trade.  In Market Cap, we have favored small or mid cap since late 2019.  Thanks to the large cap growth winners, this proved costly on a relative basis until August, but since then clients have regained a lot ground on a relative basis.  The extreme outperformance of large caps for the last five years driven by growth stocks tricked our models.  Now that a sustained shift has taken place, we believe it will have legs.  In Style, we captured most of the growth stock outperformance as we mostly favored large cap growth over the past five years.  At the start of October, we moved to neutral and sold half our large cap growth exposure and reinvested in large cap value.  So far, the timing has been excellent.

It is important to note that we are not bearish on growth stocks, large or small.  We just expect small and mid cap value stocks and COVID losers to lead the market higher in the months ahead. This is expressed in client portfolios though our ownership of individual stocks including Alphabet, Apple, Activison Blizzard, Facebook, and Home Depot.  We also have value and COVID loser exposure with Comcast, Disney, Nexstar Media Group, IBM, and ViacomCBS. Viacom and Nexstar have been huge winners over the last few months.

Overall, we like Northlake’s positioning in our equity portfolios.  Between our models and individual stocks we have a barbell of large cap growth/COVID winners and small and mid cap value/COVID losers.  The balance should work if the market can continue to move higher as we expect.

Many clients are still carrying above average cash balances despite reinvestment this summer into stocks including Home Depot, VICI Properties, and preferred stocks of CGI Liberty and Qurate Retail.  We are actively looking for new ideas at both ends of the barbell to further reduce cash reserves.

MDY, IWD, IWF, AAPL, ATVI, GOOG, GOOGL, DIS, NXST, HD, VIAC, CMCSA, FB, IBM, VICI, GLIBP, and QRTEP 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.