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, NBER, Avalon Investment & Advisory as of July 01, 2019

Chart of the Week: Despite the better-than-expected jobs report last week, Fed funds futures are still pricing in a 100% chance of at least a 0.25% cut in rates at the July 31 Federal Reserve meeting. Prior to the stronger jobs report, markets were pricing in a bit more than a 25% chance of a 0.50% cut. The odds of a cut that large are now priced at less than 2%. Why is a cut still expected at all with the job market clearly still holding up? Oddly, the answer might be partially found in the fact that the current U.S. expansion has just become the longest one on record going back to 1854. Despite the history-making duration, this expansion has been sub-par in terms of growth relative to history (see chart). Avalon’s view is that the Fed is still likely to deliver a July “insurance” cut of 0.25% due to the combination of relatively slow growth, inflation as measured by Core PCE well below the Fed’s 2% target, market expectations and various risks to the expansion (trade disputes, Iran, slowing global growth). Last week our analysis noted that stocks typically rallied into an insurance cut and continued to perform well in the year following. Markets will be listening to Chair Powell and others closely to judge the likelihood of the insurance cut.

  WEEK IN PREVIEW

  • Geopolitical: Markets will continue to monitor the progress of trade negotiations between the U.S. and China after Presidents Trump and Xi’s ceasefire at the G-20 meeting. OPEC releases oil market report, including demand forecast and OPEC production.
  • U.S.: Fed Chairman Powell testifies before Congress on monetary policy and the state of the U.S. economy. The Fed also releases minutes of its June meeting and delivers nine speeches. After the strong labor data last Friday, the comments with the impact on the probability of rate cut in July will be closely monitored (Please see the Chart of the Week for more). PEP, FAST and DAL are among companies to report Q2 earnings this week. Consumer (CPI) and producer (PPI) inflation readings for June are both expected at 1.6% year-over-year (Y/Y) down from 1.8%. Atlanta and NY Fed estimates of 2Q GDP growth are 1.31% and 1.48%.
  • Europe: Germany industrial production for May rose 0.3% with the Eurozone and U.K. readings expected to tick up to 0.2% and 1.5% respectively from below zero last month. German May trade data showed export growth and less contraction of imports. The European Central Bank releases the account of their June meeting and at least six members are scheduled to speak. U.K. Conservative Party members vote to choose Theresa May’s successor. The next PM likely named around mid-July with about three months remaining until the October 31 Brexit deadline.
  • Asia: Japan May core machine orders declined -3.7% Y/Y with the Tertiary Industry Index expected to reverse to a decline later in the week as well. China June foreign reserves increased to $3,119 billion. Between the ongoing trade dispute and the weakness of the Yuan versus the dollar, China June trade data should still show Y/Y declines for exports and imports in U.S. dollar terms but are expected to grow in Yuan terms. June China CPI Y/Y should hold steady at 2.7%.
  • Central Banks: The central banks of Israel, Canada, Malaysia, Serbia, Sri Lanka, Peru and Egypt 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.

  WEEK IN REVIEW

  • The S&P 500 reached a new record high last week and was up almost 1.7%. Communication services (2.7%), real estate (2.4%) and technology (2.2%) were the strongest sectors; while energy (-0.9%), industrials (0.1%), and materials (0.5%) underperformed the S&P 500 the most. WTI and Brent crude prices were lower, but MLPs advanced almost 2%. Small cap stocks underperformed with the Russell 2000 only up 0.6%. The 10-year U.S. Treasury yield increased to 2.03% as the chances of a half percentage point cut in rates at the July meeting evaporated with the better than expected jobs report last Friday. High yield credit spreads reflected increased risk tolerance by narrowing.
  • The U.S. dollar was stronger against both developed market and emerging market currencies. Developed international stocks as measured by MSCI EAFE underperformed the S&P 500 returns in U.S. dollar terms (up 0.5%); however, on a hedged-currency basis, developed market stocks were up 1.7%. Emerging market stocks underperformed the U.S., as the non-hedged return rose 0.5% for MSCI EM.
  • The 10-2 yield curve narrowed and ended at 16.9 basis points. Another curve measure of three-month yield six quarters forward – three-month yield was inverted slightly less and ended the week at -46 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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