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, NBER, Ned Davis Research, Avalon Investment & Advisory as of July 28, 2019

Chart of the Week: In our view, a global central bank easing cycle has begun which has already lifted asset prices and should improve economic growth. While the European Central Bank (ECB) did not ease last week, both lower rates and more asset purchases are on tap for September. This week the Federal Reserve (Fed) will almost certainly lower the policy rates by 25 basis points. While a cut of 50 basis points is not out of the question, recent data and Fed guidance make it a low probability in our analysis. While Fed rate cuts without an accompanying recession are historically rarer, these “insurance” cuts have been very positive for stock prices. Seven out of eight instances have seen higher stock prices in the year after the insurance cut and averaged a 23.1% gain (see chart). Fed easing accompanied by a recession (shaded) have been more challenging with only seven out of eleven higher after a year and average S&P 500 gains of only 5.3%.

  WEEK IN PREVIEW

  • Geopolitical: Markets will continue to monitor the progress of trade negotiations between the U.S. and China when talks resume in Shanghai on Tuesday, the first face-to-face meeting since May.
  • U.S.: A packed calendar with the highlight being the Fed meeting. Please see our Chart of the Week for more details. The July jobs report is projected to show nonfarm payrolls rising by 169,000, slipping from a robust 224,000 in June. Unemployment rate is expected to hold steady at 3.7% with average hourly earnings up 3.1% year-over-year (Y/Y). July readings for ISM manufacturing and Dallas Fed manufacturing outlook should improve from roughly three-year lows. The Atlanta Fed currently estimates 3Q GDP growth at 2.21%.
  • S&P500 2Q Earnings: Another big earnings week with 168 S&P 500 companies reporting: LLY, MRK, MO, MA, PFE, APPL, AMGN, GE and XOM. 44% of companies have reported so far with 77% and 61% beating earnings and sales estimates respectively. Earnings improved to -2.6% Y/Y from -3.4% the previous week after charges related to the grounding of Boeing’s 737 Max caused an earning revision. Technology led the improvement in the earnings growth rate.
  • Europe: Boris Johnson starts his first full week as the new U.K. Prime Minister with the October 31 Brexit deadline about three months away. The Bank of England is expected to keep the monetary policy rate and asset purchase target unchanged. Both July U.K. manufacturing and construction PMI should continue to reflect weakness in the economy. Eurozone 2Q GDP Y/Y expected to slow to 1.0% from 1.2%. The weakening GDP report should reinforce the already high odds of ECB action in September.
  • Asia: Bank of Japan is expected to leave monetary policy unchanged but should signal continued willingness to act to reach its inflation target. Japan’s June employment report should reflect a tight labor market. Japan’s industrial production for June could slump by -1.8% month-over-month. China official and Caixin PMI data for July are forecast to improve slightly for the manufacturing reading but should remain below the line of demarcation of 50.
  • Central Banks: In addition to the U.S., England and Japan, the central banks of Bulgaria, Brazil, Dominican Republic and Czech Republic meet with Brazil expected to lower their policy rate by 25 basis points to 6.25%.

  WEEK IN REVIEW

  • The S&P 500 reached another record high last week and gained 1.7%. Communication services (4.6%), financials (2.7%), information technology (2.4%) were the biggest outperformers; while utilities (-0.6%), energy (-0.6%), and healthcare (0.4%) were the largest laggards. WTI (1.0%) and Brent crude (1.3%) prices were higher for the week, but MLPs joined the energy sector and were down -0.4%. Small cap stocks outperformed with the Russell 2000 up 2.0%. U.S. 2Q GDP was better than expected at 2.1% growth, helped by robust consumer spending. The 10-year U.S. Treasury yield ticked up to 2.07%. High yield credit spreads reflected increased risk tolerance by narrowing.
  • 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 in both the U.S. dollar terms (-0.2%) and on a hedged-currency basis (0.8%). Emerging market stocks underperformed the U.S. with the non-hedged return down by -0.8% for MSCI EM.
  • The 10-2 yield curve flattened and ended at 21.4 basis points. Another curve measure of three-month yield six quarters forward – three-month yield inverted slightly more and ended the week at -38 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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