The Q2 factor winner? Small cap.

As global risks grow, factor diversification may help investors stay prepared

Nick KalivasTime to read: 4 min

With fears of a trade war looming over global large-cap stocks, the small-cap factor emerged as the clear winner of the second quarter. Specifically, small-cap low volatility/high dividend was the best-performing factor, followed by the small-cap versions of value, growth, equal weight and momentum (see the chart below for the indexes that represent these factors).

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Can small-cap outperformance continue?

Several drivers suggest that small caps may be able to continue their recent dominance over large caps

Nick KalivasTime to read: 3 min

Small caps have materially outperformed large caps in 2018, with the S&P SmallCap 600 Index outpacing the S&P 500 Index 7.80% to 2.58% between Dec. 29, 2017, and May 25, 2018.1 Below, I highlight the drivers of small-cap returns this year, and why I believe the trend could continue.

Tax cuts have benefited small caps. In the three years ending December 2017, the companies in the S&P SmallCap 600 Index had an average effective tax rate 4.3% higher than the S&P 500 Index.1 Investors looking for stocks that may experience improved profitability due to US tax reform have turned to the small-cap sector.

Trade tensions may favor small caps. 2018 has been a year of trade tensions, but

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Sector performance and economic cycles: When do sectors have the potential to shine?

Where we stand in the economic cycle can have a measurable effect on sector performance

Nick KalivasTime to read: 4 min

There are many determinants of stock performance. Corporate earnings, fiscal policy and interest rates can all influence the equity markets. But equity returns are also dependent on where we stand in the economic cycle.

Some sectors, such as industrials and financials, tend to display strong performance early in the economic cycle when economic growth is accelerating. Other sectors, like utilities and consumer staples, tend to be strongest very late in the economic cycle when economic growth is weakest.

How do we know this?

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How did factors perform during a roller coaster first quarter?

Growth, momentum factors prevail after a volatile start to the year

Nick KalivasTime to read: 5 min

Equities experienced heightened volatility during the first quarter of 2018, with the S&P 500 Index surging 7.55% from Dec. 31 2017, through Jan. 26, 2018, before dropping nearly 8% through quarter-end.1 Early in the quarter, market activity was buoyed by upward revisions to corporate profit outlooks following federal tax cuts in December, coupled with a squeeze on short volatility positions.

However, this momentum eased in the final two months of the quarter as investors became uneasy over a number of developments:

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What do inventories tell us about the economy?

Declining inventories and rising industrial production may create a strong backdrop for value and momentum strategies

Nick KalivasTime to read: 3 min

One benefit of factor investing lies in the cyclical nature of factors. Because various factors tend to perform differently depending on economic conditions, investors can harness these attributes to their advantage.

For example, value and momentum stocks have often been better-suited for periods of expansion. This is because value strategies tend to invest in cyclical stocks that may benefit from faster economic growth, while momentum strategies operate under the premise that stocks with strong recent performance may continue to outperform over the near term.

It’s my view that the current inventory cycle provides a favorable backdrop for equity prices and makes a compelling case for

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