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: FactSet, Avalon Investment & Advisory as of July 15, 2019FactSet, Avalon Investment & Advisory as of July 15, 2019

Chart of the Week: Second quarter earnings season for the S&P 500 kicks off in earnest with 57 companies scheduled to report. Consensus is already expecting a second consecutive year-over-year decline in quarterly earnings with 1Q earnings finishing at -0.3% (see chart). Weakness in the global economy seems to be the primary culprit for the expected decline. Companies with greater non-U.S. sales have considerably lower expectations than those with a majority in domestic sales. This week brings a heavy dose of financial companies with the big banks reporting, but the schedule also includes other sectors including some big technology names like EBAY, IBM and MSFT. Despite the low expectations, this reporting period is not necessarily a headwind to stocks. Avalon expects 2Q earnings to beat expectations and may even squeak out a positive growth rate. In addition, stocks are clearly keying in on the probable “insurance” cuts from the Federal Reserve and the future outlook, so company guidance will also be key. Avalon still expects about 5% earnings growth for 2019 versus the consensus at 2.7%. This positive expectation relies on some improvement in the global economy in the second half of 2019 and stabilization in the trade war.

  WEEK IN PREVIEW

  • Geopolitical: Markets will continue to monitor the progress of trade negotiations between the U.S. and China. European Union foreign ministers meet to discuss Iran’s non-compliance with the 2015 nuclear accord.
  • U.S.: This week gives us an important look at the U.S. consumer: June retail sales are expected to rise 0.1% month-over-month (M/M) but the core reading for GDP calculations should rise 0.3%. June industrial production forecast to slow to 0.1% M/M growth. June housing starts expected to decline slightly while building permits rise fractionally. University of Michigan Consumer Sentiment reading for July should rise to an elevated level of 98.6. Lots of Fedspeak with ten speeches on tap including Chair Powell on Tuesday plus the release of the Fed Beige Book, but there is little to suggest that any comments or data will change the almost certainty around a rate cut on July 31. Atlanta and NY Fed estimates of 2Q GDP are 1.4% and 1.49% respectively. Please see our Chart of the Week for more about this earnings season.
  • Europe: Eurozone and German ZEW expectations surveys for July are likely to reflect the dour sentiment in Europe. U.K. June consumer inflation (CPI) probably remained unchanged at 2.0% year-over-year (Y/Y). U.K. retail sales for June expected to decline M/M. U.K. Prime Minister Theresa May’s successor, likely Boris Johnson, will be announced on July 23 with about three months remaining until the October 31 Brexit deadline.
  • Asia: China’s 2Q GDP slowed to 6.2% Y/Y as expected from 6.4%. China’s June industrial production rose to 6.3% Y/Y and retail sales grew at a 9.8% Y/Y pace, both better than expected. Japan reports June trade data which is expected to improve but remain negative Y/Y. Japan CPI expected to remain stubbornly low for June.
  • Central Banks: Global central banks have generally begun another easing cycle as Fed reinforced the likelihood of the July cut and Eurozone signaled that future easing is now the baseline expectation. The central banks of Kazakhstan, Pakistan, South Korea, Indonesia, Ukraine, Chile and South Africa meet with cuts expected from Indonesia, Ukraine and South Africa. Consensus expects no change from South Korea, but the central bank could surprise with a cut as well.

  WEEK IN REVIEW

  • The S&P 500 reached another record high last week and was up 0.8%, helped by Fed Chair Powell’s comments that all but cemented a cut at the July 31 Federal Reserve meeting. Energy (2.2%), consumer discretion (2.1%) and technology (1.5%) were the strongest sectors, while healthcare (-1.4%), materials (-0.8%), and real estate (-0.2%) underperformed the S&P 500 the most. WTI (4.7%) and Brent crude (3.9%) prices were up strongly for the week, supporting the energy sector’s performance and helping MLPs advanced 1%. Small cap stocks underperformed with the Russell 2000 down -0.4%. The 10-year U.S. Treasury yield rose to 2.12%. Despite the rally in stocks, high yield credit spreads reflected decreased risk tolerance by widening slightly.
  • The U.S. dollar was weaker against both developed and emerging market currencies. Developed international stocks as measured by MSCI EAFE underperformed the S&P 500 returns in both the U.S. dollar terms (-0.6%) and on a hedged-currency basis (-0.9%). Emerging market stocks underperformed the U.S. with the non-hedged return declining by -0.9% for MSCI EM.
  • The 10-2 yield curve steepened and ended at 27.3 basis points, further discounting the likelihood of a recession. Another curve measure of three-month yield six quarters forward – three-month yield was inverted less and ended the week at -41 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 about 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 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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