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, Avalon Investment & Advisory as of August 12, 2019

Chart of the Week: Fears of economic weakness fueled by geopolitical concerns regarding the trade disputes seem likely to drive volatility in global risk assets as the uncertainty is priced in. During these uncertain times, it is good to look at what we do know. While stocks are not cheap on an absolute basis and neither are other asset classes, they do look inexpensive relative to interest rates (see chart). The S&P 500 earnings yield (earnings divided by price) minus the U.S. 10-year Treasury (green line) and BAA corporate bond (blue line) yields are both very positive. Certainly, valuations according to these measures are significantly cheaper than at the last two significant market peaks. In addition, these measures continue to indicate that stocks should outperform bonds over the long-term from these levels. While the global economy is softening and the odds are rising, there should be no imminent U.S. recession. The global central banks continued the easing cycle last week with India and New Zealand notably easing more than expected. The U.S. and Eurozone should ease again in September and this easing cycle can help offset the drag from the trade disputes. Avalon continues to monitor the situation closely but investors should be prepared for more volatility as the markets struggle with discounting the uncertainty surrounding the geopolitical risks and the economy.

  WEEK IN PREVIEW

  • Geopolitical: Markets will monitor the progress of trade negotiations between the U.S. and China as the trade dispute has escalated from an uneasy truce. Movement of the Yuan/U.S. dollar and developments surrounding possible September trade talks will be closely watched.
  • U.S.: Consumer prices (CPI) are expected to edge higher to a 1.7% year-over-year (Y/Y) pace in July. Retail sales for July should grow 0.3%, a slower pace from June’s 0.4% reading but still consistent with the consumer supporting the economy. July housing data, starts and permits, could begin to reflect some lift from the lower mortgage rates. The Atlanta and NY Fed currently estimate 3Q GDP growth at 1.95% and 1.58%, respectively.
  • S&P 500 2Q Earnings: Eleven companies are scheduled to report, including M, CSCO, WMT, AMAT and NVDA. 90% of companies have reported so far with 75% and 57% beating earnings and sales estimates respectively. Earnings improved to -0.7% Y/Y from -1.0% while the pace of sales was steady at 4.1% Y/Y.
  • Europe: The August ZEW survey for the Eurozone and Germany will be watched for any sign of improving sentiment. Eurozone’s 2Q GDP is expected to remain unchanged from the 1Q’s 1.1% Y/Y pace. Germany’s 2Q GDP probably shrank by -0.1% quarter-over-quarter as the industrial slowdown weighed. The U.K. July CPI expected to decline to 1.9% Y/Y and retail sales are expected to decline for the month.
  • Asia: Japan reports June Tertiary Industry Index and July machine tool orders. July loan and money supply data from China generally slowed from June. China’s July industrial production and retail sales are forecast to slow to 6.0% and 8.6% Y/Y respectively.
  • Central Banks: The central banks of Namibia, Norway, Mexico, and Uganda meet with all expected to hold their monetary policy rates unchanged. The Mexico decision is a close call so it may surprise with a rate cut.

  WEEK IN REVIEW

  • The S&P 500 experienced a volatile week due to escalating global trade and FX tensions including a 6% correction from the all-time peak. The market recovered much of the losses and closed at -0.5% from the previous week. Energy (-2.2%), financials (-1.7%), and information technology (-0.8%) were the hardest hit sectors; while real estate (1.8%), utilities (1.1%), and materials (0.7%) performed best. WTI (-2.1%) and Brent crude (-5.4%) oil prices declined further as economic fears from the trade tensions weighed, sending the energy sector -2.2% lower and MLPs -4.9%. Small cap stocks underperformed with the Russell 2000 down -1.3%. The 10-year U.S. Treasury yield declined to 1.75%. High yield credit spreads reflected decreased risk tolerance by widening.
  • The U.S. dollar was weaker against developed market currencies and stronger against emerging market currencies. Developed international stocks as measured by MSCI EAFE underperformed the S&P 500 returns in both U.S. dollar terms (-1.3%) and on a hedged-currency basis (-1.7%). Emerging market stocks underperformed the U.S. with the non-hedged return down by -2.3% for MSCI EM.
  • The 10-2 yield curve flattened and ended at 9.4 basis points. Another curve measure of three-month yield six quarters forward – three-month yield inverted slightly more and ended the week at -50.8 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 another 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 one to two additional 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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