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, Bloomberg as of December 2, 2019

Chart of the Week: While U.S. small cap stocks (Russell 2000) have underperformed large caps (S&P 500) by almost five percentage points year-to-date, small caps have outperformed by almost one percentage point since the end of the third quarter. There is significant evidence that the outperformance in small stocks could continue. Valuations are attractive and currently stand at over two standard deviations cheaper relative to the S&P 500 (see chart). Since valuation is a poor timing tool, it is worth noting that the Russell 2000 hit its first 52-week high in more than a year last week. According to Strategas Research Partners, the Russell 2000 was higher in the following twelve months in ten out of eleven similar instances since 1982 with an average gain of 15.2%. Small caps should also benefit if investors continue to exhibit a growing risk appetite with biotech, its second largest sector at 8.3%. The largest sector, diversified banks, at 9.9%, should benefit from improved economic growth and a steeper yield curve.

  WEEK IN PREVIEW

  • Geopolitical: Markets will continue to monitor the progress of the phase one trade negotiations between the U.S. and China. Separately, President Trump signed the Hong Kong Human Rights and Democracy Act of 2019 with China threatening to place the drafters on their no-entry list. 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. OPEC+ meets in Vienna and the Saudi Aramco IPO is expected to price on Thursday. The House Judiciary Committee holds an impeachment hearing on Wednesday.
  • U.S.: November ISM Manufacturing is expected to continue to add to the evidence that the U.S. economy is exiting its soft patch. WardsAuto's total vehicle sales for November are forecast at a 16.8 million rate with the consumer continuing to support the economy. The November monthly jobs report has the consensus expecting a strong 188,000 gain in non-farm payrolls and the unemployment rate to remain at 3.6%. The Atlanta and NY Fed currently estimate 4Q GDP growth at 1.66% and 0.77%, respectively. According to Adobe Analytics, online holiday shopping on Black Friday posted the second largest one day total ever at $7.4 billion with Cyber Monday sales this week expected to eclipse the record by a large margin.
  • Europe: Eurozone producer inflation for October is expected to fall further to -1.8% year-over-year (Y/Y). October Eurozone retail sales should decelerate to 2.0% Y/Y. Consensus has German factory orders and industrial production for October less negative than September at -4.8% and -3.6%. The UK’s political campaigns continue and a BBC debate will be held before the December 12 general election with the path forward to the January 31 Brexit deadline in the balance.
  • Asia: Japan reports October household spending, which should decline by -3.4% Y/Y following the sales tax hike. After better China November official PMI data over the weekend, the Caixin manufacturing PMI readings confirmed the bounce at 51.8 and the services reading on tap.
  • Central Banks: The central banks of Australia, Canada, Chile, Poland, Namibia, India and Botswana meet with Chile and India expected to cut monetary policy 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 reached a new all-time high during the week and rose 0.99%. Consumer discretionary (+1.8%), technology (+1.7%) and real estate (+1.4%) outperformed the S&P 500, while energy (-1.6%), utilities (-0.04%) and industrials (+0.3%) were the biggest laggards. WTI (-4.5%) and Brent (-1.5%) crude oil prices were lower for the week, weighing on the energy sector (-1.6%) and MLPs (-1.7%). Small cap stocks outperformed with the Russell 2000 up +2.2%. The 10-year U.S. Treasury yield moved slightly higher to 1.78%. High yield credit spreads narrowed, reflecting increased risk appetite.
  • The U.S. dollar was stronger against both developed and emerging market currencies. Developed international stocks as measured by MSCI EAFE underperformed the S&P 500 returns both in U.S. dollar terms (+0.5%) and on a hedged-currency basis (+0.7%). Emerging market stocks underperformed the S&P 500 with a non-hedged return of -0.8% for MSCI EM.
  • The 10-2 yield curve steepened to +16 basis points. Another curve measure of three-month yield six quarters forward – three-month yield also narrowed to +7 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 on hold for the remainder of 2019 and 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.

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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