Last week’s main event was the July FOMC meeting, at which the committee raised overnight interest rates by 25bp, to a target range of 5.25% to 5.50%. The accompanying statement was little changed from the previous meeting, although the committee did upgrade its assessment of current US economic growth from “modest” to “moderate”. Fed Chair Jerome Powell maintained a hawkish tone in the ensuing press conference, reiterating that monetary policy would need to remain restrictive for some time in order to bring inflation down to the committee’s 2% target.
Rates moved slightly higher across the curve in response to the fresh round of hawkish commentary, and the odds of yet another 25bp rate hike prior to year-end increased a bit in futures markets. Meanwhile, the market now foresees no rate cuts prior to March of next year.
Equities remained surprisingly buoyant despite the melt-up in rates, perhaps driven by encouraging macro data that raised hopes for a soft landing. The first estimate of Q2 GDP growth came in at +2.4% annualized, showing sequential acceleration in the economy that exceeded consensus estimates. Meanwhile core CPE fell to +3.8% annualized in the quarter, consistent with higher frequency inflation data that has been released in recent months. The Conference Board’s Consumer Confidence index also rose sharply for the second month in a row, hitting a 2-year high at 117.0 in June.
Tech company earnings have also helped to pull the market higher of late, and last week was no exception. META (fka Facebook) rose 10% on the week after released a better-than-expected earnings and revenue growth, driving significant outperformance in the Comms sector and the Nasdaq.
Albion’s “Four Pillars”:
Economy & Earnings
The US economy showed resilience in the first half of 2023, and Wall Street analysts expect full-year corporate earnings to be roughly flat y/y. Albion’s base case expectation is that the US economy will enter recession in the second half of 2023, putting downside pressure on earnings.
The S&P 500’s forward P/E of 19.4x is above the long run average, so valuation could be a headwind to future returns. More predictive metrics like CAPE, Tobin’s Q, and the Buffett Indicator (Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.
Rates rose dramatically in 2022 due to a sharp pivot in monetary policy, and have remained elevated in 2023 as progress on inflation has been slower than hoped. Futures markets now imply that the Fed Funds overnight interest rate will remain unchanged at 5.25-5.50% until at least March of next year.
-After reaching 40yr highs in spring of 2022, inflation has moderated somewhat over the past 12 months. Goods inflation has fallen due to softening demand and excess inventory, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged.