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 June 14, 2019

Chart of the Week: With Fed Funds futures pricing in two to three rate cuts from the Federal Reserve (Fed) over the next year, the rate decision and guidance on Wednesday will be parsed ad nauseum. It will be nearly impossible for the Fed to be as dovish as the implied policy. The implied probability of a rate cut this week is over 20%, but Avalon places the odds significantly lower. The May retail sales and industrial production data reported last Friday indicate that 2Q GDP growth is running at around a 2% pace. In addition, the Fed has indicated that low inflation is transitory. Their preferred measure, the Trimmed Mean PCE from the Dallas Fed, is running at a 2% rate over the past year. The Fed is almost certain to show continued willingness to shift from a "patient" policy to one which allows for rate cuts if necessary. As Chair Powell noted in early June, the Fed is "closely monitoring the implications of these developments" when speaking about the downside risks from the trade disputes and other issues. While Avalon still believes it is premature to see a cut Wednesday and only one in 2019 is currently likely, recent history demonstrates mixed results of market performance a year after the first Fed’s rate cut of the cycle. Three out of five times, the market was up a year after the first rate cut, and in two other times, the market was down by another 20% or more.

  WEEK IN PREVIEW

  • Geopolitical: Markets will continue to monitor the progress of the trade negotiations between the U.S. and China closely. News about any plans for a meeting between President Trump and Chinese President Xi Jinping at the G-20 meeting in Japan from June 27-28 is anxiously awaited.
  • U.S.: A housing heavy week with the June NAHB Housing Market Index along with May readings for starts, permits and existing home sales. Housing has been perking up with mortgage rates falling, so all the readings should hold steady or improve month-over-month. Initial jobless claims probably ticked down slightly, reinforcing the view that the labor market remains resilient. Markit Manufacturing PMI for June expected to stay at 50.5, above the 50.0 line demarcation between growth and contraction. In addition to the FOMC meeting discussed in the Chart of the Week, the Fed will also release stress test results for the large U.S. banks which should continue to indicate a very strong capital position for the financial sector.
  • Europe: German ZEW Expectations Survey for June forecast to further weaken to -5.8 from the previous month’s -2.1. The June Markit Eurozone and German PMI readings will be watched for any sign of rebound. Eurozone Manufacturing PMI probably improved to 48.0, still below the 50.0 line of demarcation while the Service reading held steady at 53.0. May retail sales in the U.K. probably declined on both the headline and excluding auto fuel readings. The Bank of England meets and is expected to hold policy steady. The race to succeed U.K. PM Theresa May narrows down to two candidates with the next PM likely named by the end of July with about three months remaining until the October 31 Brexit deadline.
  • Asia: Japan May consumer inflation likely to slow and remain stubbornly low. May trade data expected to weaken year-over-year relative to April. All industry index for April is expected to improve and June Markit Manufacturing PMI will be reported. The Bank of Japan meets and is widely expected to leave its policy rate unchanged. No data of note expected from China.
  • Central Banks: Very busy week for central banks with the headliners of the U.S., Japan and U.K. watched closely for future guidance along with Uganda, Mozambique, Brazil, Indonesia, Norway, Taiwan, Philippines, and Colombia. Norway is expected to raise its monetary policy rate by 0.25% while the Philippines reduces its rate by 0.25%

  WEEK IN REVIEW

  • The S&P 500 posted a gain of 0.47% with May retail sales and industrial production boosting the expectations for 2Q economic growth. 2Q GDP growth estimated by the Atlanta and NY Fed at 2.05% and 1.36%. Consumer discretionary (2.4%), communication service (1.4%), and utilities (1.2%) were leading sectors while energy (-0.5%), industrial (-0.4%) and information technology (-0.2%) were laggards. WTI (-2.7%) and Brent oil (-2.0%) prices declined but MLPs were up by almost 0.3%. Small cap stocks outperformed fractionally with the Russell 2000 up 0.54%. The 10-year U.S. Treasury yield eased barely to 2.08% and high yield credit spreads reflecting increased risk tolerance by narrowing.
  • Developed international stock indexes underperformed the S&P 500 in U.S. dollar terms due to an appreciating dollar. On a hedged-currency basis, developed market stocks were up 0.64%. The U.S. dollar was also stronger against emerging market currencies as well. The non-hedged stock returns were -0.29% for MSCI EAFE and 0.76% for MSCI Emerging Markets.
  • The 10-2 yield curve steepened and ended at 23.6 basis points. Another curve measure of three-month yield six quarters forward – three-month yield continues to be inverted at -49.5 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 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 perhaps one net cut in short-term rates over the next year and a half. Much of the decline in the forward-looking three-month yield came in response to the weak European economic data and it has been retracing much of the decline as better U.S. and Chinese data are reported. Our view remains that the odds of a recession in 2019 remain low and Avalon expects only one rate hike 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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