Weekly Recap:
September is a notoriously difficult month for stocks, and so far 2024 has been no exception thanks to lingering concerns about the strength of the US economy. The S&P 500 fell every day last week and finished down more than 4%, while a rout in technology stocks dragged the Nasdaq to a nearly 6% decline. Small caps also struggled and continue to lag well behind large caps on a YTD basis.
Soft labor market data is partly to blame. Last week’s updates point to continued normalization of labor supply and demand, leaving open the question as to whether the Fed’s inflation-fighting campaign may yet cause the economy to overshoot to the downside. Per the JOLTS report, US job openings have fallen by roughly 1/2 million in the past two months as demand for labor weakens. The ADP employment report showed a net increase of just 99k payrolls, the lowest monthly total since January of 2021, before Covid-19 vaccines were widely available. And finally, nonfarm payrolls from the BLS (142k) came in slightly below consensus (165k), while the prior two months were revised lower by a combined 86k.
Yields fell across the curve in response, particularly in the front end as markets priced in an increasingly aggressive rate cutting campaign, including 4 or 5 cuts of 25bp prior to year-end across just 3 FOMC meetings. As a result of falling short term yields, the 2s10s curve went and stayed positive for the first time since it originally inverted in July of 2022. It is likely that over the next 18-24 months, the “normalization” theme that has applied to so much of the post-pandemic economy over the past couple years will finally begin to apply to the yield curve as well, gradually restoring its natural upward slope.
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 20.6x 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 enact multiple interest rate cuts across the last three FOMC meetings 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 3-4% 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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