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 June 7, 2019

Chart of the Week: While much attention has been paid to the inversion of the U.S. 10-year yield minus the 3-month yield (meaning the 3-month yield is above the 10-year), less attention has been paid to other yield curves. But what is the bond market telling us? First, the 3-month yield is expected to decline precipitously as evidenced by the 3-month yield 18-months in the future now being priced at more the 0.5% lower than the current 3-month (3M18MFed-3Mo). In other words, the inversion of the 10Y-3Mo could prove temporary. In addition, the 10-year yield is still above the 2-year and in fact recently began to steepen. This means that the bond market is not pricing in a policy error and believes the Federal Reserve (Fed) will cut rates. Markets are now pricing in an almost 100% chance of a rate cut in 2019 and a high probability of two to three cuts over the next year in the wake of the weak employment report on Friday. Avalon currently expects one cut in 2019 and will be watching initial job claims closely to judge if more cuts are likely since the Fed should be more sensitive to job losses with inflation remaining tame. While U.S. 2Q GDP growth seems likely to be weak, growth should remain decent for the calendar year. Stocks are likely to continue to be volatile and buffeted by trade developments. Global yields seem likely to remain low but move relatively higher as global growth worries recede.

  WEEK IN PREVIEW

  • Geopolitical: Markets will closely monitor any new developments in the U.S. trade disputes with China and Mexico. President Trump announced late Friday afternoon that a deal regarding illegal migration to the U.S. has been reached with Mexico, thus the tariffs on Mexican imports originally scheduled to begin this week will not be implemented. The OPEC oil report, including demand forecasts and production, will be released on Thursday.
  • U.S.: May producer and consumer inflation are expected to continue to be benign with lower inflation likely to further fan the flames of Fed rate cuts. Initial jobless claims are projected at 215k and will be closely watched for further indication of weakness in the job market after the poor employment report last week. Retail sales for May are expected to improve significantly. 2Q GDP estimates from the Atlanta and NY Fed are 1.39% and 1.01%.
  • Europe: U.K. and Eurozone industrial production for April are expected to post declines. Eurozone June Sentix investor confidence should moderate. U.K. unemployment rate probably stayed at 3.8% in April. The race to succeed U.K. PM May will heat up with the first Conservative Party leadership ballot; a new PM is expected next month. Any credible Brexit plan will need to wait for new leadership and even after that the way forward is unclear.
  • Asia: Japan 1Q GDP quarter-over-quarter annualized likely revised up to 2.2% from 2.1%. April tertiary industry index for Japan expected to improve. China’s May foreign reserve rose slightly to $3,101 billion from the prior $3,095 billion. Chinese exports rose by 1.1% year-over-year (Y/Y) in U.S. dollars but with the significant depreciation of the yuan, it equates to +7.7% Y/Y in local terms. Imports fell -8.5% Y/Y in U.S. dollars, but -2.5% Y/Y in yuan terms. China’s industrial production expected to rise 5.4% Y/Y and retail sales Y/Y may increase to 8%.
  • Central Banks: The central banks of Turkey, Namibia, Georgia, Switzerland, Peru and Russia meet with Russia expected to cut their monetary policy rate by 0.25%. With global growth slowing some central banks that have been on the sideline for some time are now starting an easing cycle. For example, last week Australia cut rates for the first time in about three years and Chile cut for the first time since 2017.

  WEEK IN REVIEW

  • The S&P 500 posted a gain of over 4.4% as the market weighed the higher chances of Fed cutting rates and improving trade tension. All S&P 500 sectors closed higher with materials (+9.1%), information technology (+6%) and consumer staples (+5.2%) the leading sectors. WTI (+0.9%) and Brent oil prices (-2.0%) were mixed; MLPs posted a gain of 1.0% with the energy sector up 4.1%. The 10-year U.S. Treasury yield fell to 2.08%, 10-year yields in Germany and Japan moved further into the negative. Both high yield credit spreads and investment grade credit spreads improved with the rally in stocks.
  • Developed market stocks underperformed the S&P 500 as the MSCI EAFE posted a 2% gain on a hedged-currency basis. Emerging market international stock indexes also underperformed the S&P 500 in U.S. dollar terms with a gain of 0.9%. The U.S. dollar was weaker against both developed market and emerging market currencies. The non-hedged MSCI EAFE posted a 3.2% gain.
  • The 10-2 yield curve widened to 23 basis points. Another curve measure of three-month yield six quarters forward – three-month yield narrowed its inversion to -56 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 a year or more 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 a significant cut in short-term rates over the next year and a half. Our view remains that the odds of a recession in 2019 remain low despite the trade conflict but Avalon now expects some easing 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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