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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Source: Avalon Investment & Advisory, Strategas as of January 6, 2020

Chart of the Week:  With the revival of some market volatility following the escalation of tensions between the U.S. and Iran, our analysis looks at the historical stock volatility during election years via the intra-year declines (See Chart). Interestingly the average intra-year decline during presidential election years is a little over -12% versus almost -14% for the market over the last forty years. While it is a small sample, the data provides no evidence that presidential elections necessarily add to downside risk. It is worth noting that the worst intra-year decline for the S&P 500 in 2019 was -7%, so a relative increase in the downside volatility for 2020 would actually be consistent with both long-term market and presidential election year averages. Declines during presidential election years are typically followed by strong returns in the following year which is consistent with overall market history as well. Avalon sees a very low risk of recession in 2020 and almost all large market declines (see 2008) are typically associated with recession.

  WEEK IN PREVIEW

  • Geopolitical: Markets will continue to monitor the details of phase one and progress on phase two trade negotiations after the U.S. and China reached a limited trade deal. President Trump and China’s President Xi should have a formal signing of the phase one trade deal in mid-January. The situation in the Middle East following the escalation of tensions between the U.S. and Iran will be monitored for potential impact on the markets.
  • U.S.: December ISM Non-Manufacturing readings are expected to improve to 54.5, while November factory orders should decline -0.7% month-over-month. The December employment report should remain strong with nonfarm payrolls increasing by 162,000 and the unemployment rate holding steady at 3.5%. The Atlanta and NY Fed currently estimate 4Q GDP growth at 2.33% and 1.13% respectively.
  • S&P 500 Earnings Preview: 4Q 2019 earnings season begins in earnest the week of January 14, but four S&P 500 companies report this week. Earnings for the quarter are expected to decline -1.5% while sales rise 2.6% year-over-year (Y/Y). Avalon expects another quarter of earnings beats that will bring earnings into the positive for the quarter. Avalon forecasts 5% - 7% earnings growth for the S&P 500 in 2020.
  • Europe: November Eurozone retail sales are expected to improve to 1.5% Y/Y. Eurozone consumer inflation for December is estimated to rise to 1.3% Y/Y. Germany reports November trade data. The U.K. parliament is expected to approve PM Johnson’s Brexit bill to depart the European Union by the January 31 deadline.
  • Asia: Japan November household spending expected to improve to -2.0% from -5.1% Y/Y after the increased sales tax caused the sharp decline in October. China December Caixin Services and Composite declined to 52.5 and 52.6 from 53.5 and 53.2 respectively. China PPI and CPI for December are forecast at -0.4% and +4.7%.
  • Central Banks: The central banks of Romania, Poland, Serbia, Israel and Peru are scheduled to meet with no changes in monetary policy rates expected.

  WEEK IN REVIEW

  • The S&P 500 halted its New Year’s rally after the rise in tensions in the Middle East and posted a -0.2% decline for the week. Industrials (+1.1%), energy (+0.8%) and technology (+0.4%) outperformed the S&P 500, while materials (-2.5%), consumer staples (-1.5%) and healthcare (-1.0%) were the biggest laggards. WTI (+2.2%) and Brent (+0.6%) crude oil prices were up for the week, helping the energy sector (+0.8%) and MLPs (+1.3%). Small cap stocks underperformed the S&P 500 with the Russell 2000 down -0.5%. The 10-year U.S. Treasury yield fell to 1.79%. High yield credit spreads widened, reflecting decreased risk appetite.
  • The U.S. dollar was weaker against developed but stronger against emerging market currencies. Developed international stocks as measured by MSCI EAFE outperformed the S&P 500 returns in U.S. dollar terms (+0.0%) but underperformed on a hedged-currency basis (-0.4%). Emerging market stocks outperformed the S&P 500 with the non-hedged return of +0.5% for MSCI EM.
  • The 10-2 yield curve flattened to +26 basis points. Another curve measure of three-month yield six quarters forward – three-month yield narrowed to +2 basis points. The yield curve has historically provided an accurate forecast of future recessions when the difference in these measures turns negative, also known as inversion. Yield curves are one of the major indicators that we monitor to judge recession risk, but these inversions typically happen more than a year in advance of an economic recession. In addition, stocks have historically had significant advances post-inversion. The three-month yield six quarters forward yield is now reflecting that the market expects very little net moves in short-term rates over the next year and a half. Our view remains that the Federal Reserve is likely on hold for 2020 and the odds of a recession over the next twelve months remain below 50%. Avalon continues to monitor the data closely. Please see our Avalon Perspectives publication, The Yield Curve and Equity Returns, from April 26, 2018, for more details.

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Phan Phan Duong, Senior Analyst

 

Henry J. Lartigue, CFA, Managing Partner

 

Samuel E. Rines, Chief Economist

 

Bill Stone, CFA, CMT, Chief Investment Officer

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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