February 01, 2010
Back to Small Caps as Market Cap Model Volatility Continues
Northlake’s Market Cap model continues to show unusual volatility, reflecting the volatile economic and financial market environment. For February the model is sending a small cap signal. As a result, all Northlake model-driven, client positions in mid cap (MDY) have been sold and the proceeds have been reinvested in small cap (IWM). The Style model remains firmly on a Value signal. As a result, all client positions in the Russell 1000 Value (IWD) are being maintained.
The Market Model has switched signals for three straight months and five of the last six. This is very unusual volatility. The last time something similar occurred was in mid-2005. The volatility is tied to the maturing of the first phase of economic and financial market recovery. Economic statistics have moved off their dire readings to somewhat normal levels for the early stage of an economic recovery. At the same time, financial markets have stabilized and in some cases, such as stocks, staged a huge rebound. This leaves the economy and financial markets in limbo awaiting the next big move. With many of the model’s underlying indicators moving from extreme readings to normal readings, the monthly “score” of the model sits right in the middle of its 0 to 100 range. Thus, changes in the indicators lead to greater than usual volatility in the monthly signals.
Interestingly, the Style model is exhibiting little volatility. The value signal has been in place since July 2009. A couple of things are at work. First, the style model made a strong move into value territory in the first month or two of the current signal. This makes modest changes in the underlying indicators less likely to change to the monthly signal. Second, by virtue of having just two options, growth or value, the Style model has longer average holding periods.
The current value signal strengthened considerably for February and is now at is strongest level since early 2005. For February, two underlying indicators moved from growth to value. Coincident Indicator of economic growth is now accelerating on a year over year basis, a clear positive for more economically value stocks and consistent with the recent GDP report showing the economy is growing economy. The stock market trend indicators also shifted to value as growth stocks suffered from a sharp sell-off in technology stocks. Expect the value signal to remain in place for the next couple of months.
In January, the models performed fairly well. The value signal worked as IWD fell 2.8% against a decline of 4.5% for the comparable growth index and 3.7% for the S&P 500. Since July, IWD has slightly outperformed the comparable growth index. The January mid cap signal was accurate but added minimal value. MDY fell 3.2%, holding up better than the S&P 500 and the Russell 2000 Small Cap (IWM) which each fell 3.7%.
Disclosure: IWM and IWD are widely held by clients of Northlake Capital Management, LLC including in Steve Birenberg's personal accounts. MDY and SPY are core holdings for some clients of Nortlake Capital Management, LLC, including in Steve Birenberg's personal acocunts. IWM and SPY are short positions, solely for the purpose of hedging, in the Entermedia Funds. The Entermedia Funds are co-managed and co-owned by Steve Birenberg, who has a significant personal investment in the Funds.
Posted by Steve Birenberg at February 1, 2010 11:23 AM in Models