There were no changes to Northlake’s Market Cap and Style models for December. The signals remain on large cap and growth. As a result, client portfolios continue to own the S&P 500 (SPY) and the Russell 1000 Growth (IWD).
It looks like we could get a move in the Market Cap signal fairly soon, however. The model reading is on the very cusp of switching to a mid cap signal. If that occurs, positions in SPY will be sold in favor of the S&P 400 Mid Cap (MDY). For December five of the ten indicators in the model favor large cap and five favor small cap, a shift of two indicators in favor of small caps. Falling rates and widening yield spreads led to shifts this month. Lower rates definitely favor small caps which presumably have less access to capital. The credit crisis has widened spreads enough that they are now in a mode where in the past small caps have outperformed. These two indicators join bearish market sentiment, the steepening yield curve, and low consumer confidence in the camp favoring small caps. As a reminder, small caps often perform best when sentiment and the economy look worse. The model attempts to look ahead toward the next big move and when things look bleak the next big move is often up which creates an environment where the added volatility of small caps works in favor of investors.
The Style model, on the other hand, looks unlikely to make a shift away from growth any time soon. The model is still firmly in growth mode reflecting sluggish economic growth where unit growth stories are more valuable to investors. For December, two of the underlying indicators moved from value to growth mode: measure of relative strength for consumer stocks and the return of the yield curve to a normal upward sloping shape.
I find the current model signals consistent with my own views of how to invest in a weakening economy. My big worry about the current signals is that a countertrend rally in favor of small caps and value (financials are a big component of value indices) seems overdue.