There were no changes again this month to Northlake’s Market Cap and Style models. The signals continue to flash mid cap and growth. As a result, I am maintaining client and personal positions in the S&P 400 Mid Cap (MDY) and the Russell 1000 Growth (IWF) that are dedicated to this strategy.
Both signals weakened slightly this month but stayed firmly in their current recommendations. On RealMoney.com, two contributors who I greatly respect, Bob Marcin and Rev Shark, have been sharing their concerns about small and mid caps needing to catch up on the downside, especially as it relates to beta and risk aversion. However, one thing that goes unsaid in those comments is that there are some previously reliable indicators which are currently suggesting that now is a favorable environment for small and mid caps.
Unusually weak consumer confidence is a contrarian call favoring small caps. Weak coincident indicators are also consistent with future small cap outperformance in a contrarian sense. Historically wide credit spreads also have lined up with small cap outperformance in the past on a contrary basis. The current environment is unusual to say the least so the indicators may be off but not everything is lined up against small and mid caps.
And there are some indicators that clearly suggest caution toward small and mid caps….

….Rising interest rates are definitely a problem as is the recent weakening in market breadth and initial underperformance of small and mid caps. Dollar weakness also favors large caps although a lot of folks expect the dollar to strengthen.
On the Style side, the indicators remain mostly unchanged with the exception of forward earnings yields which now favor value. That is mostly due to the collapse in value stock prices on a relative basis over the past year. Cheap is not always good but it is worth noting that this indicator finally indicates we are in cheap territory.
Last month the models were accurate. Mid Caps fell 7.4% against an 8.6% decline for the S&P 500. Growth outperformed the S&P as well with IWF falling 6.9%. The Russell 1000 Value Index suffered again, declining 9.5%. The models have also been accurate over longer time frames as well. Growth has been favored since July 2007 during which IWF is down 7% and IWD is down 20%. Mid Cap has been in favor every month this year except April. For the year so far, the Market Cap model is off a bit over 6% while the S&P 500 is off almost 13%. I’m a believer in reversion to the mean so this run of good calls makes me nervous in the very short-term but these models have a great track record and I never try to out guess them.
As always, special thanks to Ned Davis Research who originally developed these models and continues to maintain them.