There were no changes this month to Northlake’s Market Cap and Style models. The signals remain small cap and growth. As a result, within the index rotation portion of client portfolios, I will continue to hold positions in the Russell 2000 Small Cap Index (IWM) and the Russell 1000 Growth Index (IWF).
The small cap signal has been in place since September. For April, the signal is slightly stronger than it was in March due to an improvement in NYSE Monthly Breadth. Breadth improved dramatically last month as the market came off its lows. A breadth thrust of this nature has usually led to strong out performance for small cap stocks. Better breath is usually associated with rising markets and indicates that investor appetitive for risk has improved. Both these characteristics favor small cap stocks wit their higher volatility.
There were no other changes in the factors underlying the Market Cap model. Eight of the ten factors now favor small caps. This is not surprising given that the market and economy are at historically bearish extremes. There is a contrarian nature to both models so with many measures at extremes the models assume the next move is reversion to the mean. For market cap, a less bearish market and economic environment is a time to take incremental risk and own small caps.
The growth signal has been in place since the beginning of February. There were no changes to the underlying factors for April with six of the nine indicators favoring growth. The Style model is picking up the very weak economic environment which favors relative performance for less cyclically sensitive growth stocks. Value indices have a lot materials, industrial, and financial stocks which need an economic tailwind to perform well. Growth stocks get a boost in a weak economy because of the relative strength in their fundamental operating performance.
The Style model also has a contrarian slant at market and economic extremes so my main concern is that stabilization in the economic environment will lead to a sharp rebound in value stocks as investors rotate toward economically sensitive sectors.
The March model signals provided little value added. Small, mid, and large cap and growth and value indices all performed in very narrow band as the market rally was a rising tide, lift all boats event….

Since the current small cap signal went into effect in September 2008, it has inaccurate as the Russell 2000 has underperformed the S&P by about 5%. The current growth signal has performed very well since the start of February with the Russell 1000 Growth outperforming the Russell 1000 Value by over 6%.
Given the extraordinary times, I am cognizant of the fact that the models are built on historical data and correlations. It is plausible that “this time is different” and the models will be less accurate. My concern is lessened by the passage of time which is allowing some relationships to normalize and early sings that the economy is stabilizing. These models have a superior track record approaching 30 years. Now is not the time to panic.
If you have fresh fund s to invest or need to rebalance your portfolios, you should be looking at indices or individual stocks with small cap and growth characteristics.
Northlake clients own positions in IWM and IWF including positions held in my personal accounts.