Perspectives & Commentary

Avalon produces a variety of investment commentaries.

Our perspectives and quarterly commentary are issued throughout the year and cover a range of investment-related topics.

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There was no shortage of third-quarter headlines. The global economy slowed further, and the U.S. economy showed similar signs of pressure. The U.S. consumer continued to be the hero with consistent spending holding the U.S. economy out of a recession. Manufacturing indicators were (nearly) uniformly worse in the U.S. as well as abroad. Simply, the retreat to a slower growth world picked up the pace.

 

Yields followed the economic data lower with the U.S. 10-year sitting comfortably under 2% for much of the quarter. Without a substantial and sustainable acceleration in global growth, these lower yields are likely to persist. The Federal Reserve made good on its tentative commitment to lower interest rates with 0.25% cuts at both their July and September meetings with another expected by the end of 2019.

 

With the backdrop of a decelerating global economy, political headlines dominated the airwaves. The announcement of impeachment proceedings against President Trump is the most topical, but there was also the debacle of the U.K.’s Prime Minister Boris Johnson’s Brexit scheming.

In the end, the quarter started much as it finished. The U.S. and China are still muddling through a trade deal, and the global economy continues to slow. The story is unlikely to change in the fourth quarter with the U.S. economy likely to cool a bit further, and the global economy not showing signs of a dramatic turnaround. For now, the low yield, slow-growth world is likely to stay in place.

IMPEACHMENT DOES NOT CHANGE ANYTHING

Impeachment proceedings will dominate the headlines and commentary will bombard from all angles. This is unfortunate because while policies have an effect on economic and market outcomes, impeachment does not.

 

Impeachment has the potential to impact consumer sentiment and that could damage the U.S. economy. A surge in Republican sentiment following the 2016 Presidential election is persistent, and this is a tailwind for consumption. What if the impeachment proceedings are detrimental to this trend? The consumer is the cornerstone of the U.S. economy. Can it bump the U.S. into a recession?

Interestingly, the answer is a solid “no”. During the Clinton Administration, there was one scandal after another. But the economy was strong and consumer comfort for both Republicans and Democrats moved higher throughout the 1990s. There was little to no economic reaction to the news of impeachment.

 

Not to mention, there was considerable angst concerning the U.S. and global economy at the time of the impeachment proceedings. The ISM Manufacturing Index – which measures expansion of the manufacturing sector when readings are above 50 and contractions when the data is below – broke through 50 in June of 1998. It remained below 50 until early 1999. In the interim, the Federal Reserve was cutting rates but not by too much. It was a sort of “mid-cycle adjustment”. History rhymes.

Back to the present, the effects of trade uncertainty and the global slowdown will continue to linger in the system for some time. Again, this is not entirely different from the 1990s with the Asian Crisis and the collapse of Long-Term Capital Management. There are always uncertainties. Now, the uncertainties regarding trade and the outlook for the economy are elevated.  Confidence in the economy one year out among CEOs has fallen sharply as the trade war and uncertainties take their toll. This has unwound most of the upside gained following the election of President Trump and portends further deceleration in business investment in the near future.

The cyclical, manufacturing-oriented portion of the U.S. economy is not in great shape, and there are few signs that it is turning around. However, this is not the entirety or the majority of the U.S. economy. That designation lies with consumption driven by the consumer, and the consumer is doing well. Employment and wage gains remain healthy, and impeachment proceedings should not alter the economic growth trajectory.

IMPACT OF IMPEACHMENT AND ECONOMIC FEARS ON STOCKS

With House Speaker Pelosi announcing an impeachment inquiry into President Trump, our assessment of past periods surrounding impeachment hearings indicates that while politics do matter, the economic backdrop is likely a more dominant factor. It is impossible to predict the outcome with any precision, but with the president’s political party controlling the Senate, it will be a high hurdle to get the supermajority of two-thirds of Senators to find the president guilty. Though there are only two impeachments to analyze in the modern era, it seems that regardless of the outcome the trends that were in place prior to any impeachment proceedings continued and markets were driven by other factors.

After a brief respite from concerns about a U.S. recession, the weak September ISM Manufacturing reading brought those fear back to the forefront. Our analysis of history shows that both the fears of recession and poor stock returns after the ISM falls below 50 are overblown. Since 1946, the U.S. economy has fallen into recession only 44% of the time when the ISM has crossed below 50. In addition, returns from the S&P 500 are generally significantly positive in the year after such an occurrence. To parse the data more closely, the S&P 500 is higher one year later in 86% of the time when there is no recession and 55% of the time when it leads to recession.

CONCLUSION

With impeachment news likely to dominate headlines, investors should be prepared for volatility. The larger drivers of stocks are likely to continue to be trade conflicts along with economic and earnings growth. Avalon still believes that despite some of the recent data, a U.S. recession is not imminent so the combination of low yields and over $3.4 trillion sitting in money market assets should continue to support stocks and risk assets generally. However, short-term declines in stocks should be expected as the market struggles with the slowing economy and trade headlines.

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November 2017

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News | Press

Avalon Advisors, LLC Announces new Co-Chief Investment Officer

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This report is furnished for the use of Avalon Investment & Advisory and its clients and does not constitute the provision of investment or economic advice to any person, nor the recommendation of any security. Persons reading this report should consult with their investment advisor regarding the appropriateness of investing in any securities or adopting any investment strategies discussed or recommended in this report. Statements regarding future prospects may not be realized. The information contained in this report was obtained from sources deemed reliable. Such information is not guaranteed as to its accuracy, timeliness, or completeness by Avalon Investment & Advisory. The information contained in this report and the opinions expressed herein are subject to change without notice. Past performance is no guarantee of future results. Neither the information in this report nor any opinion expressed herein constitutes an offer to buy or sell, nor a recommendation to buy or sell, any security or financial instrument. Avalon Investment & Advisory does not provide legal, tax, or accounting advice. ©2019 Avalon Investment & Advisory. All rights reserved.

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