Weekly Recap:
Most equity benchmarks finished in the green once again last week, albeit with different leadership this time. Tech stocks took a step back on Thursday and Friday, particularly the semiconductor companies (Nvidia, Broadcom, Taiwan Semiconductor Manufacturing, Qualcomm, etc.) that had been fueling the recent rally. In the end, cyclicals and small/midcap stocks outperformed on the week as what had been a very narrow rally broadened out a bit.
Despite a variety of macro updates that in the aggregate were a bit weaker than expected, rates moved higher by 3-5 basis points across the curve. Meanwhile, IG corporate credit spreads widened for the 3rd consecutive week, and have now widened by nearly 10 basis points on average since the end of May.
Most of the macro updates from last week suggested a gradually softening outlook for the US consumer, including:
* US retail sales ex autos fell 0.1% sequentially for the 2nd straight month
* The NAHB Housing Market Index fell 2 points to 43 in June
* Housing Starts fell 5.5% m/m on a seasonally adjusted basis in May
* Residential Building Permits fell 3.8% m/m on a seasonally adjusted basis in May
* The Conference Board LEI fell 0.5% m/m and is now -14.2% off its cycle peak
However, there were a few bright spots that allowed cyclicals to rise, including:
* Industrial Production rose 0.9% m/m in May
* US Manufacturing Capacity Utilization rebounded 50bp to 78.7% in May
* S&P’s Manufacturing PMI rose to 51.7 in preliminary June data
* S&P’s Services PMI rose to 54.8 in preliminary June data
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 21x is well above the long run average, so valuations are likely to 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 from current levels over the coming decade are likely to be in the single digits.
Interest Rates
Futures markets imply that the Fed will cut overnight interest rates once or twice in 2024, most likely at some point in the 2nd half of the year. Belly and long end rates are already at or near what are likely to be their post-pandemic equilibrium levels, unless the US economy enters a recession.
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. Volatile energy prices driven by geopolitical conflicts could present a risk to the inflation outlook.
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