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April 04, 2007

April 2007 Model Signals

For the second consecutive month there were no changes to Northlake's Market Cap and Style models. The signals are still flashing large cap and value. As a result, in the portion of the portfolios Northlake manages that are dedicated to the ETF rotation strategy, I continue to own the S&P 500 (SPY) and the Russell 1000 Value Index (IWD).

Despite the lack of changes in the signals, there is some exciting news. The Market Cap signal favoring large cap is at its strongest level since November and December of 1995! In fact, the signal strength is in the top ten going all the way back to the beginning of my measurement period in 1980. For what it's worth, the 1995 signals proved accurate as large caps outperformed small and mid caps over the next three months and especially in months six through eighteen following the signal. The models are designed to offer signals over an intermediate time frame which I define as six to twelve months. The average holding period for the market Cap model in the 25 plus years of back testing is five months....

The Market Cap model contains ten factors, all of which now favor large cap. I divide the factors into three buckets: economic, interest rate, and stock market/technical. In general, the model has favored large caps when the market returns are about average. Small cap signals usually occur when the market and economy have been doing poorly for awhile. The idea is to move into what is going to work next so there is a contrarian aspect. The stock market/technical indicators include some trend based factors to keep me from being too late or too early. Ned Davis Research developed these models and continues to maintain them.

The Style model had no changes this month to any of the underlying factors leaving the reading exactly the same as last month. I'd classify the reading as a "weak value" signal. Over the past six to twelve months, the Style model has not been sending strong signals as it has rotated a few times between growth and value. Over this time frame, returns on the major growth value indices have not shown significant variation.

So far in 2007, the signals from both models have been pretty accurate. Thanks mostly to a call favoring mid cap to start the year, the Market Cap model produced a price-only gain of 1.07% in the first quarter vs. just .19% for the S&P 500. The Style model benefited similarly from a good call on value to start the year and produced a first quarter gain of 1.89%.

Posted by Steve Birenberg at April 4, 2007 01:19 PM in Models