Aerospace and defense: Investment opportunities are on the radar

A potential increase in defense spending and an uptick in commercial aircraft orders could boost the industry’s prospects

Nick KalivasThe defense industry has been a strong performer since the Nov. 8 US elections. Between Nov. 8, 2016, and Feb. 24, 2017, the SPADE Defense Index has rallied 14.54% — outpacing the S&P 500 Index by more than 3%.1 Given the scale of the Trump administration’s proposed defense budget, as well as positive trends in commercial airline orders, I believe prospects are favorable for aerospace and defense firms.

US aerospace and defense orders are rising

After showing flat to declining growth since 2010, US defense orders — which include aircraft, related parts and other military hardware produced by the Department of Defense — have been trending upward and are now approaching

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Three reasons building and construction stocks have risen

Improved corporate profits, new activity could be key to future performance

Nick KalivasInfrastructure spending has been a hot topic since the November elections. Building and construction stocks have been buoyed by the outlook for infrastructure spending — most Democrats in Congress and President Donald Trump agree that additional spending is needed to improve our infrastructure. The Dynamic Building & Construction Intellidex Index rallied 17.73% between Nov. 8, 2016, and Feb. 21, 2017 — well ahead of the S&P 500 Index, which rose 11.23% during this same period.1 A cyclical recovery in the economy is also creating tailwinds for leading indicators of construction activity.

Here are three reasons I believe building and construction stocks have moved higher:

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How have factors responded to investors’ newfound optimism?

Pairing factors can help capitalize on market trends, while providing a potential hedge

Nick KalivasAlthough investment factors have shown the ability to outperform market-cap-weighted benchmarks over time, factors are cyclical by nature — falling in and out of favor depending on market conditions. In my view, a particularly useful way to assess performance and grasp shorter-term cyclical factor movements is by considering excess returns on a 12-month rolling basis.

Excess return is defined as the difference in return between a factor index or exchange-traded fund (ETF) and a benchmark index, such as the S&P 500 Index. Assessing excess returns on a rolling basis captures performance in overlapping 12-month periods — allowing investors to gauge the consistency of returns over time.

With that in mind, let’s take a look at rolling 12-month excess returns for a small sample of investment factors versus the S&P 500 Index. The chart below begins in April 2012, based on the inception date for the longest-tenured of these factor indices.

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Examining factor performance in the fourth quarter of 2016

Small caps and value stocks shined amid a period of wide performance dispersion

Nick KalivasFactor returns showed wide dispersion in the fourth quarter, with a nearly 20% spread between the best and worst performers.1 During the quarter, investment performance was powered by economic fundamentals and expectations of additional economic and profit growth following November’s elections.

Fourth-quarter factor performance influenced by investor expectations

The US economy was already on an upswing before Nov. 8, but some market participants are anticipating potential  deregulation and tax cuts with the incoming Trump administration. If enacted, such policies could further stimulate the economy, although some market observers are concerned about potential trade disruptions. These expectations alone were enough to influence factor performance late in the fourth quarter.

Below are fourth-quarter 2016 factor returns. Note that I’ve added additional performance data covering the period following the Nov. 8 elections through the end of the year.

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Using factor analysis to explain the performance of dividend strategies

Factor tilts have resulted in divergent dividend strategy performance following the November elections

Nick KalivasNovember’s US elections have buoyed investor optimism about the potential for tax reform, increased infrastructure spending, reduced regulation and accelerating economic growth. These expectations led to a 0.75% spike in the 10-year Treasury yield between Nov. 8 and Dec. 16, and a 5.2% increase in the US dollar, as measured by the US Dollar Index.1

Still, by historical standards, interest rates remain low. Nearly a decade ago, the 10-year Treasury yield finished 2007 at 4.02%; it now stands near 2.50%.1 When adjusted for inflation, even the 0.75% bump in the 10-year Treasury yield amounts to a modest 0.40% increase. Compare that with the average annual real (inflation-adjusted) increase in the 10-year Treasury yield between January 1962 and November 2016 of 2.40%.1

Shouldn’t dividend stocks be underperforming?

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