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 26, 2019

Chart of the Week: Until China and the U.S. escalated the trade war on Friday, Fed Chair Powell’s comments at Jackson Hole were the big news of the week. Powell noted that the tariffs on China have an impact on the Fed’s actions. So, the additional tariffs announced by both China and U.S. on Friday make at least a 0.25% cut in September almost a sure thing and there is an outside chance of a 0.50% cut. Last week’s piece focused on yield curve inversion (2-year U.S. Treasury yield was higher than the 10-year) and its poor record as a market timing tool. This week our chart shows the flattening of two curves and the further inversion of the 10 year minus 3 months yield. While the implications for the stock market and possible recession can be debated, these curves are showing that investors should expect more rate cuts from the Fed. The U.S. economy is certainly slowing, but the data does not indicate an imminent recession. As Friday made clear, Avalon’s view that investors should be prepared for more volatility as the markets struggle with the discounting of uncertainty surrounding the geopolitical risks and the economy remains the proper stance.

  WEEK IN PREVIEW

  • Geopolitical: Markets will monitor the progress of trade negotiations between the U.S. and China as the trade dispute escalated again last week from China’s retaliatory tariffs and President Trump’s reaction. Movement of the Yuan/U.S. dollar, tweets and likelihood of September trade talks will be closely watched for any signs of deterioration or improvement. France hosts the G-7 summit with global trade and Brexit key subjects of discussion. During the G-7 meeting, the U.S. and Japan announced an agreement in principle for a trade deal.
  • U.S.: Durable goods orders for July provides a datapoint of how the trade war has impacted business spending with business equipment orders expected to slow. The second reading of Q2 U.S. GDP is expected to be slightly lower at 2.0%. July personal income should slow its growth slightly to 0.3% month-over-month (M/M) while spending rises to 0.5% M/M. The Conference Board’s August consumer confidence reading should betray growing fears but remain at elevated levels. The NY Fed currently estimates 3Q GDP growth at 1.76%.
  • Europe: German IFO sentiment for August proved dour. Eurozone economic confidence is expected to fall further for August. With the continued softness in Eurozone data, further stimulus from the European Central Bank (ECB) is almost certain in September. Brexit is fast approaching on October 31. U.K. parliament is set to debate no deal Brexit on September 3 which could also result in a general election.
  • Asia: Japan monthly labor data for July should continue to reflect a tight labor market with unemployment at 2.3% and job-to-applicant at 1.61. Japan’s July retail sales expected to decline -0.9% M/M, but industrial production forecasted to rebound to 0.3% M/M. China’s August manufacturing PMI likely to remain unchanged at 49.7 while non-manufacturing could post a modest decline to 53.6.
  • Central Banks: The central banks of Hungry, Iceland, Israel, Guatemala, South Korea, Botswana, Bulgaria and the Dominican Republic meet with no expected changes in monetary policy rates. Global central banks have continued to ease policy with both Indonesia and Egypt cutting rates last week and Avalon expects both the U.S. and Eurozone to ease in September.

  WEEK IN REVIEW

  • The S&P 500 closed -1.4% lower in a week that was poised to end higher before trade tensions between the U.S. and China escalated on Friday. Utilities (0.2%), consumer discretionary (0.1%) and real estate (-0.3%) were the best performing sectors; while materials (-3.1%), communication services (-2.0%) and energy (-2.0%) were the worst performers. WTI (-1.3%) and Brent crude (1.2%) oil prices were mixed for the week, but both the energy sector (-2.0%) and MLPs (-1.7%) were laggards. Small cap stocks underperformed with the Russell 2000 down -2.3%. The 10-year U.S. Treasury yield declined to 1.54%. Despite the widespread declines in stocks for the week, high yield credit spreads went in the opposite direction by narrowing.
  • The U.S. dollar was weaker against developed currencies and stronger against emerging market currencies. Developed international stocks as measured by MSCI EAFE outperformed the S&P 500 returns in U.S. dollar terms (0.8%) and outperformed on a hedged-currency basis (0.6%). Emerging market stocks outperformed the U.S. as well with the non-hedged return higher by 0.4% for MSCI EM.
  • The 10-2 yield curve slightly inverted at -0.02 basis points. Another curve measure of three-month yield six quarters forward – three-month yield inverted slightly more and ended the week at -65.3 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 to three 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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