Weekly Recap:

A combination of solid economic data, a cool(ish) inflation print, and subdued rate volatility allowed stocks to post solid gains last week.

Beginning with the economy, S&P Global’s US Manufacturing (50.3) and Services (52.9) PMIs both surprised to the upside in December. The manufacturing print was the highest in 15 months, and only the 2nd time above 50.0 (expansion territory) during that period. Meanwhile, durable goods orders (ex transports) rose +0.6% sequentially in the preliminary December reading, while the prior month was revised higher by 10bp to +0.5%. Personal spending of +0.7% m/m in December also bested consensus estimates. Mortgage applications and pending home sales rose, as the recent moderation in rates continues to filter through to the housing market. Finally, labor market indicators remained strong, with little change in jobless claims.

Those trends all contributed to a strong initial estimate of Q4 US GDP growth, which registered at +3.3% q/q on an annualized basis, far outpacing the +2.0% consensus. The US economy enjoyed a solid growth trajectory in the second half of 2023, pushing full-year GDP growth to +2.5% after sub-trend growth during the first part of the year. Consensus estimates for 2024 GDP stand at +1.5%. See the Chart of the Week for quarterly annualized GDP growth along with next year’s consensus.

On the inflation front, December’s Core PCE Deflator (the Fed’s preferred inflation gauge) registered at +0.2% m/m in December, and at just +2.9% on a y/y basis. This marks the first sub-3% y/y Core PCE print since March of 2021, ending a streak of 32 consecutive months above 3%. Bond markets took this print in stride, having largely priced in the Fed’s ultimate victory over inflation. Equities welcomed the rate stability, as the forward P/E on the S&P 500 expanded to 20x consensus 2024 earnings.

Albion’s “Four Pillars”:

Economy & Earnings

The US economy was resilient last year, and Wall Street analysts expect full-year 2023 corporate earnings to be roughly flat y/y versus 2022. Analysts are forecasting approximately 10% EPS growth in 2024; growth of that magnitude will depend on the economy avoiding recession.

Valuation

The S&P 500’s forward P/E of 20x 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 (Eq Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.

Interest Rates

Rates rose dramatically in 2022 due to a sharp pivot in monetary policy, and remained elevated in 2023 as the Fed continued fighting inflation. Futures markets imply that the Fed will cut rates significantly in 2024, possibly beginning as early as the March meeting.

Inflation

After reaching 40yr highs in spring of 2022, inflation has moderated significantly over the past 18 months. Goods inflation has fallen due to softening demand and supply chain normalization, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged.