Weekly Recap:
The “Santa Rally” period (typically defined as the last five trading days of the year plus the first two of the new year) got off to a solid start last week, but then stalled on Thursday and Friday as rising rates in the belly and long end proved to be a headwind for US equities. Nevertheless, gains from Monday/Tuesday allowed most US and international equity benchmarks to finish in positive territory for the week.
As many have predicted, the Treasury yield curve has steepened of late, driven by a combination of solid economic growth, lingering inflation pressures, and concerns regarding the trajectory of US budget deficits. The 2s10s curve finished at +29 basis points, the highest level in nearly 3 years. See the Chart of the Week for a 2s10s time series.
Macro news was limited last week due to the holiday. Durable goods orders were down -1.1% in preliminary November data (-0.1% ex transports), while new home sales rose +5.9% on a seasonally adjusted basis in November after being down sharply in October. Initial (219k) and continuing (1.9mn) jobless claims were in line with recent trends.
Perhaps the most notable macro update was an 8-point sequential decline in the Conference Board’s Consumer Confidence Index, from an upwardly revised 112.8 in November to 104.7 in December. Most measures of consumer confidence showed a significant post-election bump higher, but this update from the Conference Board suggests that the boost in sentiment may have been short-lived as Americans continue to grapple with inflation and other concerns.
Albion’s “Four Pillars”:
Economy & Earnings
The US economy has been resilient despite the higher interest rate environment. S&P 500 earnings are on track for high single-digit y/y growth in 2024, with consensus calling for an acceleration to double-digit y/y growth in 2025.
Valuation
The S&P 500’s forward P/E of 22x 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 mid single digits.
Interest Rates
After the “hawkish cut” at the December 2024 FOMC meeting, a near term pause on further rate cuts is likely, and the curve has mostly resumed its normal upward slope. Belly and long end rates in the 4% to 5% range may represent the “new normal” given solid economic growth, lingering inflation pressures, and large US fiscal deficits.
Inflation
After the disinflationary trend resumed in the summer of 2024, more recent inflation data has shown some renewed signs of stickiness. Services inflation remains somewhat elevated, in part due to heavily lagged shelter costs.
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