Weekly Recap:

Stocks were mixed and bond yields rose after higher-than-expected CPI and PPI prints dampened investors’ enthusiasm regarding near term interest rate cuts:

* Headline CPI was +0.3% m/m & +3.1% y/y (consensus +0.2% m/m & +2.9% y/y)

* Core CPI was +0.4% m/m & +3.9% y/y (consensus +0.3% m/m & +3.7% y/y)

* Headline PPI was +0.3% m/m & +0.9% y/y (consensus +0.1% m/m & +0.6% y/y)

* Core PPI was +0.5% m/m & +2.0% y/y (consensus +0.1% m/m & +1.6% y/y)

Bigger picture, the disinflationary trend largely remains in place, but as expected the final leg of the journey back to the Fed’s 2% target is proving to be a somewhat slow and bumpy ride.

In response, futures markets pushed the first “odds on” FOMC rate cut from May to June. Yields rose across the Treasury curve, particularly in the front end as market participants once again recalibrated their expectations regarding the path toward monetary policy normalization.

Meanwhile, credit spreads tightened yet again, cushioning the downside in US corporate bonds.

Finally, equity performance was strictly ordered by duration last week, with technology and other growth stocks lagging while dividend-paying cyclicals and defensives were better. Energy stocks also got a boost from rising oil prices as tensions rose in the middle east amid signs of escalation in the conflict between Israel and Hamas. Small and midcap benchmarks outperformed large caps on the week, mostly due to differences in industry composition.

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 low double digit 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 likely 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.