Weekly Recap:

For the first time all year, technology, communications, and consumer discretionary (collectively the “growth sectors”) all underperformed the broader market last week. Meanwhile, every cyclical and defensive sector outperformed. This same sector pattern resulted in small and midcap stocks beating large caps, and international benchmarks outperforming the US.

The bond market also reflected a mild risk-off sentiment last week, with rates falling 5-10 basis points across the curve. Jerome Powell’s congressional testimony made it clear that rate cuts are coming later this year unless inflation data inflects higher, but the committee is not ready to begin monetary easing just yet.

Much of the selloff in growth occurred on Friday in the wake of the February jobs report from the Bureau of Labor Statistics. To our eyes, there was little in the report that was of particular concern.

* Nonfarm payrolls rose 275k (consensus estimate was 200k)

* Unemployment (U-3) ticked higher by 20 basis points to 3.9%

* Average hourly earnings rose 0.1% m/m, and are up 4.3% y/y

* Labor force participation held steady at 62.5%

Other labor market data was solid last week as well. Jobless claims remain low, the ADP reported a net gain of 150k payrolls, and the Job Openings and Labor Turnover Survey (aka, the JOLTS Report) tallied 8.86 million open jobs in the US, down just slightly from 8.89 million the prior month.

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.