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 9, 2019

Chart of the Week: August ISM Manufacturing reading fell below the 50.0 level at 49.1 signaling contraction kicked off last week with poor economic data. Lower ISM Manufacturing readings have certainly been associated with recessions in the past, but the reading has fallen below 50 twice since the financial crisis without the U.S. slipping into recession (see chart).  While ISM Manufacturing has a good track record of predicting recession historically, it has become a less accurate predictor as manufacturing’s share of the U.S. economy has declined. Despite the current signs, Avalon believes the odds of a recession remain low due to better readings from the ISM Non-Manufacturing and the continued resilience of employment and the consumer. Goldman Sachs noted that ISM Manufacturing readings below 50 have been associated with strong returns from stocks when there is no recession with the median 12-month forward returns for the S&P 500 at 22%. Our narrative remains that the global economy is slowing with manufacturing bearing the brunt while trade conflict headlines add to the financial market volatility and central banks ease aggressively to offset the economic drag.

  WEEK IN PREVIEW

  • Geopolitical: Markets will monitor the progress of trade negotiations between the U.S. and China. Movement of the Yuan/U.S. dollar, tweets and the expected October face-to-face trade talks in DC will be closely watched for any signs of deterioration or improvement. With the extradition bill, allowing extraditions to China, formally withdrawn, Hong Kong will be watched for signs of calming the protests. OPEC+ meets on Thursday regarding crude oil production.
  • U.S.: August producer (PPI) and consumer (CPI) inflation data will be watched for implications for next week’s Fed meeting with CPI expected to remain at 1.8% year-over-year (Y/Y). With manufacturing struggling, all eyes are on the consumer so August retail sales will be closely monitored. Retail sales are expected to slow from their torrid July pace but still show growth of 0.2% month-over-month (M/M). The Atlanta Fed and NY Fed currently estimate 3Q GDP growth at 1.47% and 1.55%, respectively. Apple (AAPL) has a new product launch on Tuesday.
  • Europe: July Eurozone industrial production expected to be better but still with room for improvement at -1.4% Y/Y. With no real signs of economic improvement, the European Central Bank (ECB) is essentially certain to ease monetary policy with a signal of further easing should it be necessary. ECB should cut the policy rate to at least -0.50% while tiering the rate to protect banks. In addition, asset purchases are likely to be announced or at least telegraphed as future action. While Brexit is fast approaching on October 31, there remain many possible paths being explored including a deadline extension. Recent actions by the U.K. parliament do make a no-deal Brexit less probable, helping the pound and risk sentiment. U.K. July industrial and manufacturing production improved for the month but remain poor Y/Y at -0.9% and -0.6% respectively.
  • Asia: Japan 2Q GDP was confirmed at 0.3% quarter-over-quarter or 1.3% annualized. China August trade data showed the impact of the ongoing trade conflict with exports -1.0% Y/Y and imports -5.6% Y/Y. China August CPI and PPI expected at 2.6% Y/Y and -0.9% Y/Y respectively.
  • Central Banks: In addition to the ECB, the central banks of Kazakhstan, Poland, Malaysia, Serbia, Turkey and Peru meet. Turkey is expected to cut their rate. Global central banks have continued to ease policy and Avalon expects the Eurozone to ease this week and the Fed next week.

  WEEK IN REVIEW

  • The S&P 500 closed +1.8% for the week continuing its rally with better news regarding trade, Brexit and Hong Kong. Energy (+2.6%), consumer discretionary (+2.6%) and technology (+2.4%) were the best performing sectors, while utilities (+0.4%), healthcare (+0.7%) and materials (+0.9%) were the laggards. WTI (+2.6%) and Brent crude (+1.8%) oil prices were higher for the week, helping the energy sector (+2.6%) while MLPs declined (-0.8%). Small cap stocks underperformed with the Russell 2000 up +0.7%. The 10-year U.S. Treasury yield rose to 1.56%. Consistent with increased risk appetite, high yield credit spreads narrowed.
  • The U.S. dollar was weaker against both developed currencies and emerging market currencies. Developed international stocks as measured by MSCI EAFE outperformed the S&P 500 returns in both U.S. dollar terms (+2.2%) and on a hedged-currency basis (+1.9%). Emerging market stocks underperformed the U.S. as well with the non-hedged return of 2.4% for MSCI EM.
  • The 10-2 yield curve is no longer 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 -61.2 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 0.25% 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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