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August 07, 2007

August 2007 Model Signals

There were no changes of Northlake's Market Cap and Style models for August. The signals continue to be Large Cap and Growth. The large cap signal remains one of the strongest in the close to 400 monthly readings I have going back to 1980. The growth signal move from weak to solid this month and is the strongest reading in favor of growth since the value trend kicked of in 1999. There have been a couple of false starts since then but ultimately the trend reverted to value. I think this time the growth signal will hold for awhile. Both signals were accurate in July when the market dived lower. Large caps fell 3% last month but the decline in mid caps and small caps was 5% and 7%, respectively. Growth fell about 2-4% last month vs. declines 5%-8% for value.
Given the lack of changes in the models, I decided to offer you a post I did for Real Money describing the latest reading on the Style model and providing some background on how the model works and the theory behind it. The comments work for the Market Cap model as well. This might be a good refresher course.

Posted On RealMoney.com on August 2, 2007 at 8:08 ET:

I've posted before that I use monthly models originally developed by Ned Davis Research to rotate substantial funds between the Russell Growth and Russell Value ETFs. My definition of growth and value is whatever Russell puts in these indices. I am buying growth or value as an index, not an individual stock. The model chooses one index or the other with the goal of being in the best performing index.

The model shows an unmistakable trend toward growth after favoring value for much of the past seven years....

The latest update came out Wednesday morning morning and is the strongest growth reading since March 2000. There have been several readings close to this strong since mid-2005 when the long period of strong value readings ended. This may be another false start but I am betting against it.

Yesterday, Bob Marcin, Noah Blackstein, Norm Conley, and Tom Au were debating growth vs. value. While it seemed like they were on opposite extremes (Noah and Norm vs. Bob and Tom), I think that something Bob wrote is actually common ground. Bob said, "Growth is not due, value is not due. No style is ever due. There are just sets of conditions, i.e. fundamental growth rates and valuations. Period."
The key part of Bob's quote is "there are just sets of conditions." The Ned Davis models measure economic, interest rate, stock market, and technical indicators to see if conditions that have previously had predictive value are coming into alignment in favor of one or the other. Over the past few months, the conditions that in the past have favored growth are coming into alignment again.

In particular, narrow but expanding credit spreads, a weak dollar, decelerating economic growth, and a steepening yield curve are conditions that historically have favored growth. Additionally, growth as a class is cheap on a relative P-E basis, trading below the typical premium growth stocks are accorded compared to value. Several months of outperformance by growth have also pushed trend and technical indicators into positions that in the past have presaged additional periods of growth outperforming.

I don't know if we are at the beginning of a multi-year trend favoring growth but I believe for the next few months at least growth will be the place to be.

Posted by Steve Birenberg at August 7, 2007 09:13 AM in Models