The latest signal from Northlake’s Market Model shows a rare shift to small cap.  As a result, client portfolios using our model strategies will sell current positions in the S&P 400 Mid Cap (MDY) and reinvest the proceeds into the Russell 2000 (IWM).  There is no change to the growth recommendation from the Style model.  This is the 11th consecutive month the model is favoring growth.  There will be no changes to current client positions in the Russell 1000 Growth (IWF).

We have several observations regarding the shift to small cap.  First, it reflects the improving relative performance for small cap stocks over the last few months.  Second, the improved price action is a direct result of consistent strength in the U.S. economy and the end of the Federal Reserve’s monetary policy tightening.  This is a powerful combination of fundamental and technical factors that offers significant potential for outperformance in small caps that are at extreme historic lows on relative price and valuation metrics.

The shift to small cap also supports Northlake’s view that stock market breadth will improve in 2024.  A shift to easier monetary policy is the next step for the Fed.  With the economy still performing well, the stage is set for lower interest rates, a weaker dollar, and better earnings growth from more economic sectors.  We have chronicled the dominance of large cap growth stocks.  A key to their fantastic performance has been earnings growth that far exceeded the rest of the market while overall economic growth and inflation were low.  We see continued superior earnings growth for large cap growth (supporting another month for the growth signal) but expect more balanced growth in 2024 as the rest of the market benefits from a favorable economic and policy environment.  Should our outlook prove correct, client accounts following thematic strategies implemented through ETFs should benefit as our favored sectors (financials, industrials, and health care) and international equities perform better.

IWM and IWF 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.