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: Strategas Research Partners, Avalon Investment & Advisory as of October 28, 2019

Chart of the Week: The Federal Reserve (Fed) meets and is widely expected to deliver the third cut of the cycle. Markets are pricing in almost a 90% chance of a 0.25% cut and Fed officials would have pushed back against markets in recent weeks if they disagreed. Clues as to the future policy path will be the real focus with attention on Chair Powell’s press conference followed by at least four other Fed speeches including Vice Chair Clarida on Friday. Interestingly, a study by Strategas Research Partners shows that stocks are higher by an average of 14% in the following six months if there are either zero or one more cut after the third versus close to flat when there are two or more additional cuts. This is consistent with Avalon’s analysis that economic mid-cycle slowdowns are consistent with better future stock returns versus recessionary conditions. Data recently has been better than feared, which lends credence to our notion that the worst might be behind the global economy. Avalon expects a rate cut this week with a pause for at least the remainder of 2019 to follow.

  WEEK IN PREVIEW

  • Geopolitical: Markets will monitor the progress of the phase one trade negotiations between the U.S. and China. It is expected that the agreement would be signed by Presidents Trump and Xi at the APEC Summit in mid-November. Movement of the Yuan/U.S. dollar and tweets will be closely watched for any signs of deterioration or improvement in sentiment around completion of this phase and future phases. China’s Communist Party holds its Central Committee meeting with the protests in Hong Kong likely discussed.
  • U.S.: 3Q GDP growth should slow to 1.6% from 2.0% in 2Q. The GM strike impacted October jobs report and is expected to show an increase of 90k and the unemployment rate ticking up to 3.6%. ISM manufacturing for October is forecast to improve to 49.0 from 47.8. The Atlanta and NY Fed currently estimate 3Q GDP growth at 1.76% and 1.91%, respectively.
  • S&P 500 3Q Earnings: With 40% of the companies in the S&P 500 reporting, 80% and 64% have exceeded consensus earnings and sales estimates respectively. Earnings are running at a -3.7% year-over-year (Y/Y) pace while sales are growing at +2.8%. Earning improved from the previous week’s -4.7% Y/Y pace due to beats across many sectors with technology the primary driver.
  • Europe: Eurozone 3Q GDP expected to show that the region grew at a sluggish pace and the Y/Y growth rate decelerated to 1.2%. UK Markit manufacturing PMI for October expected to hold steady at 48.3. The Brexit impasse continues with U.K. PM Johnson seeking a general election amid opposition attempts to block his deal. The E.U. granted a Brexit deadline delay until January 31. In any case, the probability of a no-deal Brexit has fallen sharply.
  • Asia: October China manufacturing PMI expected to remain at 49.8, while the Caixin manufacturing PMI expected to be lower at 51. Japan reports September labor market data with unemployment forecast to remain at 2.2%. Bank of Japan meets and is expected to keep the policy rate unchanged but leave the door open to additional stimulus if needed.
  • Central Banks: In addition to the U.S. and Japan, the central banks of Kazakhstan, Canada, Brazil, Mozambique, Botswana, Bulgaria, the Dominican Republic and Colombia meet with Brazil expected to cut rates. Avalon expects the global central banks will continue to ease policy to offset the trade drag on growth.

  WEEK IN REVIEW

  • The S&P 500 gained +1.2% as earnings season continued to be a positive surprise along with support from trade and Brexit developments. Energy (+4.3%), information technology (+2.5%) and industrials (+2.2%) outperformed the S&P 500, while real estate (-1.1%), consumer discretionary (-0.8%) and communication services (+0.1%) were the biggest laggards. WTI (+5.4%) and Brent (+4.4%) crude oil prices were higher for the week; the energy sector was strong (+4.3%) but MLPs did not keep up (-0.3%). Small cap stocks outperformed with the Russell 2000 up +1.5%. The 10-year U.S. Treasury yield rose to 1.79%. High yield credit spreads narrowed, reflecting increased risk appetite.
  • The U.S. dollar was stronger against developed currencies and weaker against emerging market currencies. Developed international stocks as measured by MSCI EAFE outperformed the S&P 500 returns in U.S. dollar terms (+1.3%) and on a hedged-currency basis (+1.6%). Emerging market stocks kept pace with the S&P 500 with the non-hedged return of +1.2% for MSCI EM.
  • The 10-2 yield curve slightly narrowed to +17 basis points. Another curve measure of three-month yield six quarters forward – three-month yield became even less inverted and ended the week at -6.6 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 just one net cut in short-term rates over the next year and a half in the wake of the trade deal. Our view remains that the odds of a recession over the next twelve months remain below 50% and Avalon expects a rate cut of 0.25% from the Federal Reserve this week. 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.

Phan Phan Duong, Senior Analyst

 

Henry J. Lartigue, CFA, Managing Partner

 

Samuel E. Rines, Chief Economist

 

Bill Stone, CFA, CMT, 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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