Weekly Recap:

Risk appetite returned to financial markets last week as equities experienced a broad-based rally. All sectors in the S&P 500 finished higher, led by a strong post-earnings rebound in several large cap technology stocks that pushed the Nasdaq to a 4.2% gain on the week. Small caps and international stocks also fared well.

Rate volatility eased back a bit, particularly in the front end which has come to grips with the reality of a very patient Fed. Belly and long end yields inched higher by a few basis points, but the 2y finished the week right where it began: just shy of 5%. Futures markets are now pricing in only one 25bp rate cut by year-end, down from six at the start of the year.

Meanwhile, credit spreads compressed a bit last week on the uptick in risk appetite, keeping high quality corporate bond prices flat despite the mild backup in parts of the Treasury yield curve.

Macro data was mostly fine last week – not too hot, and not too cold. The first estimate of Q1 GDP came in lower than consensus expectations, but real-time GDP estimates (like the Atlanta Fed’s GDPNow) suggest that the final figure could eventually be revised higher. Consensus estimates call for continued slow growth for the balance of 2024 (see Chart of the Week).

Finally, PCE inflation data for March came in largely in line with expectations. Headline and Core PCE both expanded by +0.3% m/m in March, as they both had the previous month. Core PCE (the Fed’s preferred inflation gauge) remained at +2.8% on a y/y basis, above the Fed’s 2% target.

Albion’s “Four Pillars”:

Economy & Earnings

The US economy has been resilient despite the higher interest rate environment. 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 once or possibly twice in 2024, most likely at some point in the 2nd half of the year. Rate cut expectations have been tempered recently due to sticky inflation prints.

Inflation

After falling rapidly in late 2022 and all of 2023, inflation has become sticky in the 3-4% range in early 2024. Services inflation remains somewhat elevated, in part due to heavily lagged shelter costs. Rising oil prices driven by armed conflicts in Ukraine and the middle east are also a risk to the inflation outlook.