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: Bloomberg, Avalon Investment & Advisory as of October 07, 2019

Chart of the Week: The ISM Manufacturing reading falling to 47.8 sent stocks sharply lower to start last week. Avalon's analysis shows that a weaker ISM is not as dangerous as the market seems to indicate. The ISM falling below 50 correctly predicted recession only 44% of the time since 1948. In fact, the ISM fell below the line of demarcation five times in the 1990s without a U.S. recession. Interestingly, the median S&P 500 returns were higher in the subsequent 12 months whether there was a recession or not. Not surprising, large declines in the S&P 500 following a lower ISM were associated with recession in 2000 and 2008. Avoiding recession does improve the odds of seeing positive returns in those following 12 months with gains in 86% of the occurrences versus 55% when there is a recession. Avalon still believes that despite some of the recent data, a U.S. recession is not imminent and 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.

  WEEK IN PREVIEW

  • Geopolitical: Markets will monitor the progress of trade negotiations between the U.S. and China with Chinese Vice Premier Liu He visiting Washington DC for trade talks on October 10-11. Movement of the Yuan/U.S. dollar and tweets will be closely watched for any signs of deterioration or improvement in sentiment.
  • U.S.: Consumer inflation for September is expected to tick higher to 1.8% year-over-year (Y/Y) while the core reading holds steady at 2.4% Y/Y. FOMC minutes from the last meeting and at least 10 speeches by Fed members will be parsed for clues as to the timing of future rate cuts in the wake of the weak ISM reading last week. U.M. consumer sentiment for October will be monitored for signs that manufacturing weakness is weighing on the consumer and consensus expects a slight easing to 92 from 93.2. The official beginning of 3Q earnings season is a week away but DAL and FAST are the S&P 500 companies reporting this week. The Atlanta and NY Fed currently estimate 3Q GDP growth at 1.76% and 2.03%, respectively.
  • Europe: German August factory orders continued to move lower at -6.7% Y/Y and industrial production is expected to remain in contraction at -4.2% Y/Y. U.K. August industrial and manufacturing production are expected to improve for the month but remain in contraction Y/Y. The Brexit impasse continues as the end of October deadline approaches. PM Johnson will try to advance his proposals and travel Europe trying to reach a deal with E.U. leaders, while opposition legislators continue to plan a strategy to prevent a no-deal Brexit if he fails.
  • Asia: Japan leading and coincident indexes both weakened in August. Japan producer inflation for September expected flat for the month but -1.1% Y/Y. China September foreign exchange reserves were slightly lower. Caixin services and composite PMI for September will be released and are expected to be little changed.
  • Central Banks: The central banks of Israel, Uganda, Peru, Serbia and Sri Lanka will meet with Peru 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 was -0.3% for the week as increasing expectations of an October rate cut and the September jobs report with the unemployment rate hitting a new cycle low of 3.5% helped offset concerns over economic slowdown driven by the weak ISM readings for September. Information technology (+1.1%), healthcare (+0.9%) and consumer staples (+0.6%) outperformed the S&P 500, while energy (-3.8%), materials (-2.5%) and industrials (-2.4%) were the biggest laggards. WTI (-5.5%) and Brent crude (-5.7%) oil prices were down for the week, weighing on the energy sector (-3.8%) and MLPs (-0.8%). Small cap stocks underperformed with the Russell 2000 down -1.3%. The 10-year U.S. Treasury yield declined to 1.53%. High yield credit spreads widened, reflecting lower risk appetite.
  • The U.S. dollar was weaker against both developed currencies and emerging market currencies. Developed international stocks as measured by MSCI EAFE underperformed the S&P 500 returns in both U.S. dollar terms (-2.5%) and on a hedged-currency basis (-2.2%). Emerging market stocks underperformed the S&P 500 with the non-hedged return of -0.5% for MSCI EM.
  • The 10-2 yield curve widened to +11.9 basis points. Another curve measure of three-month yield six quarters forward - three-month yield became more inverted and ended the week at -46.5 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 two net cuts in short-term rates over the next year and a half in the wake of the weak ISM readings for September. Our view remains that the odds of a recession over the next twelve months remain below 50% and Avalon expects one additional rate cut of 0.25% from the Federal Reserve in 2019. 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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