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 September 3, 2019

Chart of the Week: Despite some better U.S. economic data and signs of de-escalation in the trade war that combined to help send stocks sharply higher, global bond yields continued to move lower. In fact, German government bond yields which were negative even on their 30-year bond went even more negative. U.S. yields also moved lower with the 30-year Treasury closing at 1.96%. The S&P 500 dividend yield is now essentially at the same level with bonds and the projected 2019 dividend yield a little higher at 2.0% (see chart). This would be only the third time in the modern era when the dividend yield is higher than the 30-year with the previous two instances happening before significant stock rallies. In any case, the relative dividend yield does add some valuation support to stocks with short-term yields seemingly destined to move significantly lower and almost $3.4 trillion sitting in money market funds. The global economy is certainly slowing while central banks ease aggressively to offset the drag of the global trade conflicts, so investors should be prepared for more volatility as the markets struggle with trade headlines and economic uncertainty.

  WEEK IN PREVIEW

  • Geopolitical: Markets will monitor the progress of trade negotiations between the U.S. and China. 15% U.S. tariffs on about $110bn of Chinese goods took effect on September 1, while China raised tariffs on various U.S. agricultural products. Movement of the Yuan/U.S. dollar, tweets and the likelihood of September trade talks will be closely watched for any signs of deterioration or improvement. Argentina implemented capital controls to defend the peso.
  • U.S.: ISM Manufacturing readings for August are expected to show little change. August auto sales report will be monitored as an indicator of consumer strength. In the biggest release of the week, nonfarm payrolls should rise by 146,000 in August, slightly below July’s 164,000 reading. Unemployment should stay steady at 3.7% and average hourly earnings rate of increase slow to 3.0% year-over-year (Y/Y). The Atlanta Fed and NY Fed currently estimate 3Q GDP growth at 2.04% and 1.80%, respectively. Fed Beige Book and seven speeches by Fed members will be monitored for monetary policy implications with the highlight being Chair Powell on Friday.
  • Europe: July Eurozone retail sales expected to decline. German factory orders and industrial production should continue to post Y/Y declines. With no real signs of economic improvement, significant stimulus from the European Central Bank (ECB) is almost certain in September with a signal of further easing should it be necessary. In order to judge the extent of the easing, speeches from various ECB members will be monitored. 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. U.K. August manufacturing and construction PMIs deteriorated further and remain in the contraction zone at 47.4 and 45.0 respectively.
  • Asia: Japan 2Q capital spending slowed to 1.9% Y/Y, while August vehicle sales slowed to 4.0% Y/Y. China Caixin manufacturing PMI for August improved to 50.4, but the official manufacturing PMI was reported lower at 49.5 providing a mixed picture with Caixin services upcoming.
  • Central Banks: The central banks of Australia, Chile, Canada, Georgia, Sweden, Ukraine and Russia meet. Chile, Ukraine and Russia are expected to cut rates. Global central banks have continued to ease policy and Avalon expects both the U.S. and Eurozone to ease in September.

  WEEK IN REVIEW

  • The S&P 500 rebounded sharply and closed +2.8% for the week. Industrials (+3.6%), communication services (+3.4%) and financials (+3.2%) were the best performing sectors, while consumer staples (+1.6), utilities (+1.8%) and real estate (+1.8%) were the laggards. WTI (+1.7%) and Brent crude (+1.8%) oil prices were higher for the week, helping the energy sector (+2.8%) and MLPs (+2.8%). Small cap stocks underperformed with the Russell 2000 up +2.4%. The 10-year U.S. Treasury yield declined to 1.50%. Consistent with increased risk appetite, high yield credit spreads narrowed.
  • The U.S. dollar was stronger against both developed currencies and emerging market currencies. Developed international stocks as measured by MSCI EAFE underperformed the S&P 500 returns in both U.S. dollar terms (+0.9%) and on a hedged-currency basis (+1.6%). Emerging market stocks underperformed the U.S. as well with the non-hedged return of 1.1% for MSCI EM.
  • The 10-2 yield curve further inverted at -1.4 basis points. Another curve measure of three-month yield six quarters forward – three-month yield inverted slightly more and ended the week at -74.6 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 more than a year 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 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 two to three additional rate 0.25% 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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