Weekly Recap:

Stocks and bonds rallied last week, thanks in part to a PCE inflation print that came in right on the screws. Investors watched with a wary eye after the most recent CPI report had come in hotter than expected a couple weeks prior, but PCE did not cause the same level of consternation:

* Headline PCE Deflator was +0.3% m/m and +2.4% y/y

* Core PCE  Deflator was +0.4% m/m and +2.8% y/y

Rates eased lower in response, after mostly moving higher in the early part of 2024. This brought some welcome relief to bondholders, who have watched bond prices sag over the past couple months, much as they did in the early part of last year. However, credit spreads also reversed course and moved wider last week, after reaching 2+ year tights the week before. This widening in spreads resulted in muted price gains for US corporates, relative to Treasuries.

Stocks were mostly better as well, particularly tech which pushed the S&P 500 and Nasdaq to fresh all time highs on Friday. Pockets of weakness in staples, utilities, and healthcare head back the Dow Jones Industrial Average, which remains just a hair below the record high set a week earlier.

The other notable macro news from last week was the somewhat surprising drop in consumer confidence across both widely followed measures. The Conference Board’s Consumer Confidence Index fell four points from a downwardly revised January figure to print at 106.7, reversing a 3-month uptrend. Meanwhile, the final reading of the University of Michigan’s Consumer Sentiment Index for February fell nearly three points from its preliminary estimate, printing at 76.9.

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.