Northlake is swapping out of purely small cap exposure, moving half to mid cap and half to large cap.  The large cap is coming from Style exposure as we stay neutral on growth vs. value but move from small cap to large cap ETFs.  In Market Cap, the swap is from small cap to mid cap in the usual stair step movement among small, mid, and large cap options.  The specific trades are: (1) sell Russell 2000/IWM to buy S&P 400 Mid Cap/MDY, (2) sell Russell 2000 Growth/IWO to buy Russell 1000 Growth/IWF, and (3) sell Russell 2000 Value/IWN to buy Russell 1000 Value/IWD.

As outlined in numerous posts over the past few years, our model has generally favored small and mid over large cap due to the historically large dispersion of returns that caused large cap to massively outperform.  The relative performance favoring large cap was fueled by growth stocks as the internet matured and the digital economy steadily grew.  This trend accelerated significantly in 2020 due to COVID.  In the fall, investors finally began to favor small and mid cap and also value and COVID losers while large cap growth winners like Facebook, Amazon, Apple, and Google stalled.  So far in 2021, the rotation has picked up steam.

In 2020, Northlake’s Style model did well to capture the move in large cap growth stocks but our Market Cap exposure lagged until the fourth quarter when small and mid cap stocks began to lead.  On the very first trading day of 2021, Northlake went all-in on small caps, swapping from mid cap to small cap for Style and moving our neutral Style exposure from large cap growth and value to small cap growth and value. 

The move to small cap worked very well. From the 2021 day one trades thru the changes today, small cap gained 14% against 11% for mid cap and just 3% for large cap.  Small cap growth and value gained 10% and 14%, respectively, against 1% for large cap growth and 7% for large cap value.  This is how our thematic rotation strategy is supposed to work, and the ability for large incremental performance gains is why it is a key part of Northlake’s overall strategy for equities.

Northlake feels like the rotation toward small and mid cap and value still has legs.  We are less certain that COVID losers will continue to outperform as valuations on many of these stocks reflect a premium valuation to pre-COVID levels on fully recovered earnings in 2022 and 2023.  Large cap growth stocks have gone sideways for seven months and valuations on many are now reasonable enough to still superior long-term growth prospects.  For these reasons, Northlake is comfortable with taking some profit on the excellent all-in small cap trade while still keeping exposure to the rotation trade through holding mid cap in the Market Cap theme.  Overall, we like having balance between large cap Style exposure and mid cap Market Cap exposure.

MDY, IWF, IWD, AAPL, FB, GOOG, and GOOGL 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.