Weekly Recap:
A sharp sector rotation trade played out across US equity markets for a second consecutive week, with high flying tech stocks coming under selling pressure while previously unloved areas of the market found a bid. Cyclicals, real estate, and small caps were areas of relative strength. The Dow was the winner among US large cap benchmarks, while the Nasdaq was down more than 3% and is now slightly in the red for the month of July. Meanwhile, international equity markets had a challenging week, and remain well behind the US on a YTD basis.
Bond yields moved higher by 5-6 basis points across most of the Treasury curve, pivoting midweek after a fairly strong bond rally that had seen yields fall by ~25 basis points over the previous 2+ weeks.
Macro was a mixed bag last week. Import/export prices continue to suggest that international trade is not a significant source of inflation at this point. On the positive side, retail sales in June were better than expected, and housing activity rebounded slightly, with permits and starts both up 3+% sequentially. On a more challenging note, jobless claims ticked higher once again as the labor market continues to normalize, and the Conference Board’s Leading Economic Index (LEI) fell another 0.2% m/m. The LEI is now 14.8% off of its peak from the end of 2021, and in the past, declines of this magnitude have always been followed by a US recession. See the Chart of the Week for a time series.
Lastly, despite causing significant disruption in many industries, it does not appear that Friday’s global Crowdstrike outage had any meaningful effect on most financial asset prices (CRWD is a notable exception, of course).
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 the 2nd half of 2024, with additional cuts in 2025. 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 became sticky in the ~3% range in the first half of 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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