The weak growth signal given by Northlake’s Style model for September turned into a weak value signal for October. As a result, I swapped all client holdings of the Russell 1000 Growth (IWF) into the Russell 1000 Value (IWD) at the open yesterday.
The one month swap from IWD to IWF for September turned out to be an OK trade from an absolute and relative basis. During the month, IWF rose 1.8% vs. a gain of 1.1% for IWD.
The average holding period for Style model based on back tests going back to 1980 is about 5 months so the one month flip flop is a bit unusual. Usually the volatility occurs when the signals are weak or in transition. I remain of the belief that we are transitioning to an environment favoring growth despite the reversion back to a value signal this month. In general, an environment of moderating economic growth favors growth and that is exactly what I expect to be the dominant economic theme for the next several months…..

Only one of the factors underlying the Style model changed this month, the index of coincident indicators moved from growth to value, but that was enough to switch the signal given the weakness of the prior month’s reading. This factor changed because the 12 month rate of change in the coincident indicators moved from negative territory to positive territory. This measurement is fluctuating very close to 0% and might remain volatile from month to month. None of the other 8 factors changed their signal for October.
Switching to the Market Cap model, the signal remains Large Cap although for the first time in six months, there was movement in favor of small caps. The movement was driven by the rally in bonds as the three month rate of change of the Lehman Long-Term Treasury index moved above 5%. Historically, bond market momentum (falling interest rates) of this magnitude has favored outperformance by small caps. Seven of the ten indicators in the Market Cap model are still flashing a large cap signal. My position in the S&P 500 (SPY) remains unchanged for October.