Weekly Recap:

Stocks were better and bond yields rose in what was for the most part a slow week for macro data. The most consequential release was undoubtedly the ISM Services Index (53.4), which came in higher than expected across the board in January, particularly the Employment (50.5) and Price Paid (64.0) components. With services being the primary source of inflation in the US economy at this point, the strength in this print was notable and will certainly influence the Fed’s thinking.

In financial media the headline was undoubtedly “S&P 5,000”, as the S&P 500 closed above this tidy (but ultimately irrelevant) milestone for the first time ever on Friday. As was the case last year, the gains in the S&P have been very unevenly distributed so far in 2024. Once again, large cap technology stocks have driven a sizeable portion of the index’s overall performance. While the market-cap weighted S&P 500 has thus far delivered a YTD total return of 5.5%, the equal-weighted version of the index has put up a return of just 0.8%.

Bond yields rose once again last week, as market participants continue to lower their assumptions about the quantity and timing of rate cuts in 2024. Relative to year-end levels, Treasury yields are now 20-35 basis points higher across the curve, with long bond yields feeling the brunt of the selling pressure. Credit spreads were stable last week and remain at tight levels relative to long run averages.

In commodity news, oil prices spiked at the end of the week after Israel rejected a cease-fire and hostage return offer from Hamas. However, natural gas prices are at multi-year lows, and gasoline prices at the pump have only edged a few cents higher in the US after falling significantly in Q4, to the benefit of consumer confidence.

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

Futures markets imply that the Fed will cut overnight interest rates several times in 2024, most like beginning mid-year. The belly and long end of the curve have already priced in a rate cutting cycle, with yields falling more than 100bp in November/December of 2023.

Inflation

After reaching 40yr highs in mid-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 somewhat elevated, in part due to heavily lagged shelter costs.