Northlake’s Style model moved decisively to value for December reflecting the “Trump Trade” that has dominated the stock market since Election Day.  Northlake client accounts will sell all holdings in the Russell 1000 Growth (IWF) with proceeds being fully reinvested into the Russell 1000 Value (IWD).  The Market Cap model remains firmly in mid cap territory, so current client holdings in the S&P 400 Mid Cap (MDY) will be held at least another month.

The Trump Trade can simply be defined as buy value and sell large cap growth and interest rate sensitive stocks.  The idea is that Trump and Congressional Republican policies will reflate the economy, leading to a pickup in economic growth.  An overriding theme since the Great Recession has been fear of deflation amid sluggish global economic growth with the policy response residing solely with Central banks.  Over the past year, Wall Street has tired of the monetary policy as a solution and hoped for fiscal policy to step up.  This has allowed the Trump Trade to be well received even if risks surrounding higher budget deficits, less global trade, a stronger dollar, higher interest rates, and a more aggressive U.S. foreign policy are ignored.

For Northlake, the painful part of the Trump Trade is that fast money investors are selling perfectly good stocks like Google and Facebook to finance their rotation into energy, industrial, and financial stocks.  The idea is understandable as growth stocks are most valuable in a low growth, low inflation environment where they can still produce gains in earnings and cash flows with little or no help from the economy.  The growth trade was in place for years so a lot of large money managers had heavy positions in their favorite growth stocks.  This is leading to aggressive selling of stocks like Google and Facebook.  Northlake thinks this rotation could continue for a few weeks or months but will ultimately be halted and reversed by (1) the still excellent fundamentals of our favorite growth companies, and (2) larger deflationary and demographic challenges that will limit any pickup in U.S. and global economic growth even with a reflation policy orientation.  Fortunately, Northlake’s models are positioned to be more responsive to near-term trends and have already benefited from exposure to value and mid caps since the election.

Following the election, Northlake raised cash reserves across most client accounts.  This proved incorrect so far as the greater risks we see from President-Elect Trump’s policies have been sidelined.  We still see outsized risks looking ahead with our focus on the impact of the stronger dollar, emerging market currency weakness, higher interest rates, and increased U.S. military activity abroad.  We also think further gains for populist and nationalist parties throughout Europe in a series of elections beginning this weekend and running through 2017 could trigger stock market downside.

We believe the best approach is to maintain above average cash reserves to provide protection against an air pocket in the stock market and to increase flexibility to adjust portfolios as fresh datapoints develop.  Trump’s campaign indicated unusual volatility that we think could be reflected in similar market volatility after his inauguration.  In the short term, we may bring cash levels down modestly as the initial Trump rally gives way to profit-taking, something we believe may have begun after the Thanksgiving holiday.

MDY and IWD 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.