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 as of August 2, 2019

Chart of the Week: Geopolitical concerns came back with a vengeance sending global risk assets, oil and yields lower last week. The clock is ticking toward a possible no-deal Brexit at the end of October with the British Pound signaling the increased risk by depreciating against the euro for 13 straight weeks. In addition, a trade skirmish between Japan and South Korea has developed. The biggest shock was on Thursday when President Trump announced a 10% tariff on the remaining $300bn worth of imports from China effective September 1. China noted that there would be “necessary countermeasures” but declined to be specific about any actions. Strategas calculates that if this additional tariff is implemented, nearly all the U.S. fiscal stimulus in 2019 will be offset by the drag from the tariffs (see chart). The tariffs look likely to stay for now with both sides needing a reason to come off their current bargaining positions. All other things being equal global growth seems likely to continue to be challenged but there is a good bit of stimulus in the system and the global central bank easing cycle has begun with notably both the U.S. and Eurozone on pace to ease in September. While the economy is softening, there should be no imminent U.S. recession. Investors should be prepared for more volatility as the markets struggle with the severity of the global economic weakness exacerbated by geopolitical risks.

  WEEK IN PREVIEW

  • Geopolitical: Markets will continue to monitor the progress of trade negotiations between the U.S. and China as the trade spat escalated last week and China vowed to retaliate. Please see the Chart of the Week for more details.
  • U.S.: July ISM non-manufacturing will be watched for signs of economic softness after the manufacturing reading disappointed last week. Producer prices for July are expected to remain stable at 1.7% year-over-year (Y/Y). The Atlanta and NY Fed currently estimate 3Q GDP growth at 1.94% and 1.56% respectively. After the markets tepid reaction to the narrative around the Fed’s rate cut, the three Fed speeches will be closely watched.
  • S&P 500 2Q Earnings: 64 companies are scheduled to report. 77% of companies have reported so far with 76% and 59% beating earnings and sales estimates respectively. Earnings improved to -1.0% Y/Y from -2.6% while the pace of sales improved to 4.1% Y/Y. Energy and Healthcare were the primary drivers of improvement in the earnings growth rate.
  • Europe: German June factory orders should improve to 0.5% month-over-month (M/M) from -2.2% while industrial production is expected at -0.5% M/M from 0.3%. With Brexit looming on October 31 and the odds of a hard Brexit rising under new U.K. leadership, the pound continues to weaken against most currencies. U.K. 2Q GDP is expected to be unchanged, bringing the pace of GDP growth down to 1.4% Y/Y from 1.8%.
  • Asia: China’s Caixin July services and composite PMI were mixed reflecting that economic growth seems to have seen little lift so far despite large amounts of stimulus. China trade data and FX reserves are reported for July. Japan 2Q GDP should moderate to 0.6% annualized.
  • Central Banks: The central banks of Romania, Australia, New Zealand, India, Thailand, Belarus, the Philippines, Serbia, Peru and Mauritius meet with New Zealand, India, and the Philippines expected to lower their monetary policy rates.

  WEEK IN REVIEW

  • The S&P 500 declined by -3.1% after reaching a record high the previous week with the proximate cause being market disappointment with forward rate guidance from the Fed and escalating global trade tensions. Consumer discretionary (-4.6%), information technology (-4.4%), financials (-3.9%) were the hardest hit sectors; while real estate (2.1%), utilities (0.3%), and healthcare (-1.1%) performed best. WTI (-1.0%) and Brent crude (-2.5%) oil prices were lower as economic fears from the trade tensions weighed on prices. The energy sector was -3.4% lower and MLPs were down -4.3%. Small cap stocks outperformed slightly with the Russell 2000 down -2.9%. The 10-year U.S. Treasury yield declined to 1.85%. High yield credit spreads reflected decreased risk tolerance by widening.
  • The U.S. dollar was stronger against both developed and emerging market currencies. Developed international stocks as measured by MSCI EAFE outperformed the S&P 500 returns in both U.S. dollar terms (-2.7%) and on a hedged-currency basis (-2.6%). Emerging market stocks underperformed the U.S. with the non-hedged return down by -4.3% for MSCI EM.
  • The 10-2 yield curve flattened and ended at 13.1 basis points. Another curve measure of three-month yield six quarters forward – three-month yield inverted slightly more and ended the week at -48 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 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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