Weekly Recap:

Last week’s market action was a product of two countervailing forces: a disappointing (but hardly surprising) reminder that the Fed is not ready to declare victory over inflation, followed by renewed euphoria regarding the potential of G-A/I after Nvidia yet again exceeded the market’s expectations with blowout Q1 earnings and revenue guidance.

Minutes from the April 30 / May 1 FOMC meeting showed that committee members are concerned about the recent stickiness in inflation, and see potential upside risks to the inflation outlook from geopolitical events via energy prices. Members cited a lack of confidence to move forward with rate cuts, a sentiment that has also been reflected in post-meeting public statements. Rates moved higher across the curve in response, particularly in the front end as the odds of a 2nd rate cut in 2024 fell to roughly 1-in-3, the lowest they’ve been all year.

After the close on that same day, Nvidia released Q1 earnings and updated revenue guidance that somehow exceeded the lofty expectations baked into consensus estimates and the stock price. NVDA rose more than 9% on Thursday, and was up another 2.6% on Friday, dragging other A/I-theme stocks higher too.

The net result of these two forces was a heavily skewed equity market, in which the S&P 500 finished slightly higher on the week at the index level, despite the fact that nearly 3/4 of the index constituents were lower. As the chart of the week shows, it is highly unusual for the index to be up when so many constituents are down. In fact, the S&P 500’s weekly net advancer/decliner score of -235 is the lowest for any week with a positive index price change in the past 30+ years.

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 20.5x 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.