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 19, 2019

Chart of the Week: As expected, the Federal Reserve (Fed) dropped the “patient” policy language and vowed to "act as appropriate" last week. Though the Fed did not cut rates at the meeting, the message was even more dovish than expected. Avalon’s base case now is that the Fed will cut rates by 25 basis points (0.25%) each in July and September. The Fed is shifting to insurance cuts in an attempt to offset the downside risks to economic growth and inflation. It is “insurance” because currently growth is satisfactory, and the labor market shows no real signs of stress. The trade dispute with China remains a major variable in the outlook and will remain a focus for both markets and the Fed. The European Central Bank (ECB) also sent a message that more easing was likely if the economy didn’t improve rather than needing further deterioration before taking action. In addition, the Bank of Japan signaled more possible easing. So why did risk assets rally globally and the S&P 500 reach a new high last week when the global economic outlook is seemingly deteriorating? Many global central banks, including the U.S., have embarked on another easing cycle and those cycles have historically boosted growth and asset prices. Several Fed speeches, including Chair Powell on Tuesday, will be parsed for differences from current market consensus.

  WEEK IN PREVIEW

  • Geopolitical: Markets will monitor the progress of trade negotiations between the U.S. and China closely with President Trump and President Xi Jinping scheduled to meet during the G-20 summit held on June 27-28 in Japan. Hostilities between the U.S. and Iran have helped lift oil prices and could provide continued headline risk.
  • U.S.: May housing data, new and pending home sales, should continue to show some improvement with the decline in mortgage rates providing a boost. May durable goods orders should improve but will continue to reflect Boeing’s woes with the 737 Max. 1Q GDP annualized quarter-over-quarter is expected to be revised to 3.2% from 3.1%. 2Q GDP growth is currently estimated at 2.05% and 1.39% by the Atlanta and NY Fed. Earnings reports start to trickle in with MU, FDX, GIS and NKE among those reporting this week. 2Q earnings season begins in earnest in mid-July, but the early reporters will be watched closely for gauging the impact of slowing global growth and trade disruptions. The Fed releases the second part of the bank stress tests which determines if capital is sufficient to raise dividends and increase buybacks.
  • Europe: Eurozone June consumer inflation is expected to remain low at 1.2% year-over-year (Y/Y) and remain part of the evidence that more stimulus from the ECB is likely. German IFO expectations component declined and Eurozone consumer confidence for June should follow suit in reflecting the economic backdrop with trade tensions, in particular, pressuring German data. The process to succeed U.K. PM Theresa May continues with the next PM likely named around mid-July with about three months remaining until the October 31 Brexit deadline.
  • Asia: Japan May retail sales Y/Y is expected to grow 1.2%. Japan’s jobless and job-to-applicant rates should hold steady at 2.4% and 1.63% in May. China reports May industrial profits.
  • Central Banks: The central banks of Hungary, New Zealand, Thailand, Iceland, Czech Republic, Guatemala, Mexico, Botswana, Bulgaria, Dominican Republic and Trinidad & Tobago meet with no major changes in monetary policy expected. Global central banks have generally begun another easing cycle with both the U.S. and Eurozone signaling that future easing is now the baseline expectation even though no changes to their monetary policy rates were made last week.

  WEEK IN REVIEW

  • The S&P 500 reached a new record high with a gain of 2.2% after the Fed showed more willingness to cut rates. WTI crude was up 9.1% and Brent 5.4% with tensions between the U.S. and Iran rising. Helped by the oil price spike, Energy (5.1%) was the leading sector. Information technology (3.3%) and healthcare (3.1%) rounded out the top sectors, with consumer staples (0.1%), materials (0.2%), and financials (0.4%) trailing. Small cap stocks underperformed with the Russell 2000 up 1.8%. The 10-year U.S. Treasury yield declined to 2.05% and high yield credit spreads reflected increased risk tolerance by narrowing.
  • The U.S. dollar was weaker against both developed market and emerging market currencies. Developed international stocks as measured by MSCI EAFE essentially matched the S&P 500 returns in U.S. dollar terms (up 2.19%); however, on a hedged-currency basis, developed market stocks were only up 1.39%. Emerging market stocks outperformed the U.S., as the non-hedged return was 3.76% for MSCI EM.
  • The 10-2 yield curve steepened and ended at 28.2 basis points. Another curve measure of three-month yield six quarters forward – three-month yield was inverted slightly more and ended the week at -51.4 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 at least two net cuts in short-term rates over the next year and a half. Our view remains that the odds of a recession in 2019 remain low and Avalon now expects two rate cuts 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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