Northlake’s Market Cap model flipped from Large Cap to Mid Cap for December.  Client positions following the model sold holdings in the S&P 500 (SPY) and reinvested the proceeds in the S&P 400 Mid Cap (MDY).  Clients using thematic strategies but not our models already have exposure to mid and small cap through core positions and Northlake’s long held view that there is a secular opportunity for good performance from small and mid cap stocks due to their historically large valuation discount.  The Style model continues to recommend large cap, although there is movement toward value that could lead to a change as soon as next month.  For now, model strategies will continue to hold the Russell 1000 Growth (IWF), while thematic strategies not using the models maintain positions in the NASDAQ 100 (QQQ).

The new mid cap recommendation and the movement toward value are driven mostly by improved stock market breadth during the current rally.  Our commentary for much of the past year has discussed the need for more stocks to participate in market rallies if the market was going to reach new highs and beyond.  There have been several false starts, but we find the current attempt for improved breadth more promising.  In the past week, the large technology stocks sold off pretty sharply even as the market averages advanced.  This pattern shift is notable because it is also being accompanied by a big bond market rally as interest rates fall.  Investors no longer expect additional interest rate increases by the Fed and statements by Fed officials indicate there are no further increases planned in the next several months at least.  Besides a return of inflation to near the 2% goal, economic data has softened modestly.  The Fed now has to maintain a better balance between inflation fighting and supporting the economy.  This syncs with improved stock market breadth since small and mid cap and value stocks have lagged due to the elevated impact of higher interest rates on their current and future business prospects compared to large cap growth stocks.

Small and mid cap, value, and Northlake’s current sector investments in financials and value will perform better if breadth expansion continues.  Consistent messaging from the Fed showing balance between inflation fighting and economic growth will be key to turning the current shift in market action to a trend.  Importantly, better breadth with small cap, mid cap and value stocks in the lead does not mean large cap growth will continue the very recent sell off.  Rather, sustained improvement in breadth can lead all stocks higher.

MDY, QQQ, 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.