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Weekly Recap:

Last week was a busy one on the macro front, with an abundance of fresh data:

* The FOMC left its policy rate unchanged at 5.25% to 5.50%

* US housing starts fell 11% sequentially to 1.28mn SAAR

* Residential building permits rose 7% sequentially to 1.54mn SAAR

* Initial jobless claims fell to 201k, the lowest print since January

* Continuing claims eased lower by 21k to 1.66mn, also the lowest since January

* S&P’s US Composite PMI was essentially flat at 50.1 (Mfg. was higher, Svc. lower)

* The Conference Board’s Leading Economic Index (LEI) fell 0.4% m/m

The decline in the LEI marked the 17th consecutive month that the index has moved lower, which is noteworthy given its strong historical track record in forecasting the US economy. The LEI is now down 7.6% on a y/y basis, and has fallen 10.5% from its recent peak at the end of 2021. Historically, y/y and absolute declines of this magnitude have always been shortly followed by a recession. See the Chart of the Week for a y/y time series.

Meanwhile, rates marched higher again last week due to a combination of factors:

* (Front end) The “dot plot” still implies one additional rate hike this year

* (Belly & long end) Concerns regarding the upcoming supply of Treasury issuance

Finally, September continues to live up to its reputation as a difficult month for stocks. The combination of higher rates, a resilient labor market, mixed signals on the strength of the US economy, and a determined Fed continue to weigh on equity valuations. The P/E multiple on the S&P 500 has lost a full turn this month, falling from 19x forward earnings at the end of August to 18x today.

Albion’s “Four Pillars”:

Economy & Earnings

The US economy showed resilience in the first half of 2023, and Wall Street analysts expect full-year corporate earnings to be roughly flat y/y. Albion’s base case expectation is that the US economy will enter recession in late 2023 / early 2024, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 18x 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 (Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.

Interest Rates

Rates rose dramatically in 2022 due to a sharp pivot in monetary policy, and have remained elevated in 2023 as progress on inflation has been slower than hoped. Futures markets now imply a roughly 50/50 chance of one additional 25bp rate hike before year-end, followed by a pause.

Inflation

After reaching 40yr highs in spring of 2022, inflation has moderated somewhat over the past 12 months. Goods inflation has fallen due to softening demand and excess inventory, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged.

Weekly Recap:

Fresh inflation data for the month of August did little to change the narrative last week. Although a supply-driven spike in energy prices drove the headline numbers higher, the disinflationary trend in core inflation remains intact. This is true for both consumer (CPI) and producer (PPI) prices:

* Headline CPI was +0.6% m/m and +3.7% y/y

* Core (ex food and energy) CPI was +0.3% m/m and +4.3% y/y

* Headline PPI was +0.7% m/m and +1.6% y/y

* Core PPI was +0.2% m/m and +2.2% y/y

All of this data was very close to consensus expectations, and Fed Funds Futures markets were largely unmoved by it. Futures continue to imply a slightly less than 50/50 chance of one additional rate hike prior to year-end, most likely at the December meeting if it occurs at all, followed by a multi-meeting pause.

Rates markets were soft despite the incoming data, particularly in the belly and long end of the curve where yields rose 7-8bp. Investment grade credit spreads remained stable near long-run averages, passing the price declines from Treasuries through to high quality corporates.

Stocks were mixed against the relatively calm macro backdrop. Tech stocks finished lower on the week, in part due to somewhat disappointing results from Oracle (relative to very lofty expectations at least) that temporarily dented investor enthusiasm for A/I story names. Most other sectors finished close to flat or slightly higher on the week. International stocks outperformed, but continue to lag the US on a YTD basis.

Albion’s “Four Pillars”:

Economy & Earnings

The US economy showed resilience in the first half of 2023, and Wall Street analysts expect full-year corporate earnings to be roughly flat y/y. Albion’s base case expectation is that the US economy will enter recession in the second half of 2023, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 19x 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 (Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.

Interest Rates

Rates rose dramatically in 2022 due to a sharp pivot in monetary policy, and have remained elevated in 2023 as progress on inflation has been slower than hoped. Futures markets now imply that the Fed Funds overnight interest rate will remain unchanged at 5.25-5.50% until at least March of next year.

Inflation

After reaching 40yr highs in spring of 2022, inflation has moderated somewhat over the past 12 months. Goods inflation has fallen due to softening demand and excess inventory, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged.

Weekly Recap:

September has often been a seasonally weak period for stocks, and so far 2023 has been no exception. Going back more than 100 years, there are only three calendar months with negative average price returns for the S&P 500: February at -0.14%; May at -0.04%; and September which is by far the lowest at -1.16% (see the Chart of the Week for monthly averages for the S&P since 1928). If instead we use median instead of average, September is the only month with a negative return (-0.56%) across more than 100 years of data. Theories abound as to whether this phenomenon is real, and attributable to factors that will persist in the future, or is merely noise. Either way, 2023 has followed the typical pattern of post-Labor Day weakness thus far.

One possible cause of weakness in stocks over the past week has been rates, which moved higher on Wednesday of last week following a blowout ISM Services PMI report for the month of August. All components of the report were stronger sequentially and well ahead of consensus, including the much-watched Prices Paid index which rose for the 2nd month in a row. ISM’s Manufacturing PMI for August was released a day prior and was generally weaker, but the Prices Paid component of that report also rose for a second straight month.

Investors responded to the stronger services data and upward trends in prices paid by adding roughly 10% to the odds of a 25bp rate hike at the November FOMC meeting. Meanwhile, the Treasury yield curve moved higher by 5-10bp, with the inversion deepening slightly as front end yields were more heavily impacted.

In the coming week the market will digest fresh inflation data (CPI, PPI, and import/export prices) for August, which will surely impact rates and stocks anew.

Albion’s “Four Pillars”:

Economy & Earnings

The US economy showed resilience in the first half of 2023, and Wall Street analysts expect full-year corporate earnings to be roughly flat y/y. Albion’s base case expectation is that the US economy will enter recession in the second half of 2023, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 19x 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 (Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.

Interest Rates

Rates rose dramatically in 2022 due to a sharp pivot in monetary policy, and have remained elevated in 2023 as progress on inflation has been slower than hoped. Futures markets now imply that the Fed Funds overnight interest rate will remain unchanged at 5.25-5.50% until at least March of next year.

Inflation

After reaching 40yr highs in spring of 2022, inflation has moderated somewhat over the past 12 months. Goods inflation has fallen due to softening demand and excess inventory, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged.

Weekly Recap:

Macro news released last week showed continued normalization of the labor market. JOLTS job openings fell to 8.8 million, the lowest print in more than 2 years. And while monthly nonfarm payrolls were in line with consensus at +187k, several of the underlying components of the report were a bit soft. Net NFP revisions for the prior 2 months totaled -110k, average hourly earnings rose just 0.2% m/m (the lowest in over a year), and the labor force participation rate rose to 62.8%, the highest level since February of 2020. Lastly, the unemployment (U-3) and underemployment (U-6) rates both rose, to 3.8% (+30bp) and 7.1% (+40bp), respectively.

Rate volatility continued to subside as August drew to a close, allowing most financial asset prices to rise. The ICE BofA MOVE Index (essentially the equivalent of VIX for interest rates) fell ~7% on the week to close at 102.92, the lowest level since early February and one of the lowest prints since the Fed first began raising interest rates nearly 18 months ago. Rate vol is still elevated relative to the second half of 2020, however, when the Fed’s ZIRP pandemic response looked set to continue for years to come. See the Chart of the Week (bottom left of the page) for a time series.

With rates (and rate vol) falling and credit spreads stable, bond prices rallied for the second week in a row. Stocks finished higher as well, with growth sectors outperforming while defensive sectors lagged. That’s been the trend throughout much of 2023, resulting in what is now fairly dramatic dispersion in YTD sector returns (see bottom right chart for details). This same dynamic (growth outperforming, defensives lagging, with cyclicals in the middle) also shows up in the YTD performance difference between the Nasdaq (+34.9%) and the Dow (+6.7%), with the S&P 500 (a blend of the two from a sector standpoint) sitting almost squarely in the middle (+18.9%).

Albion’s “Four Pillars”:

Economy & Earnings

The US economy showed resilience in the first half of 2023, and Wall Street analysts expect full-year corporate earnings to be roughly flat y/y. Albion’s base case expectation is that the US economy will enter recession in the second half of 2023, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 19x 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 (Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.

Interest Rates

Rates rose dramatically in 2022 due to a sharp pivot in monetary policy, and have remained elevated in 2023 as progress on inflation has been slower than hoped. Fed Funds Futures now show a slight odds-on probability of one addition 25bp rate hike before year-end.

Inflation

After reaching 40yr highs in spring of 2022, inflation has moderated somewhat over the past 12 months. Goods inflation has fallen due to softening demand and excess inventory, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged.

Weekly Recap:

The Jackson Hole Economic Symposium was last week’s main event, with investors focused on Fed Chair Jerome Powell’s Friday speech as an indicator of near-term monetary policy. Powell struck a hawkish tone as he continued to emphasize that inflation remains too high for the committee’s liking, and that additional policy tightening may still be warranted. An unexpected (albeit mild) increase in inflation expectations in the final August release of the University of Michigan’s Consumer Sentiment survey lent credence to Powell’s determined inflation-fighting stance.

Otherwise, macro data released last week was mixed. Existing home sales (-2.2% m/m) remain muted thanks to affordability issues and low inventory, both caused by high mortgage rates. Several regional Fed activity surveys (Philly, Richmond, and KC) remain near or in contraction territory. S&P’s US Composite PMI fell to 50.4, a third straight decline led once again by weakness in manufacturing. On the flip side, durable goods ex-aircraft came in ahead of expectations at +0.5% m/m in July, and initial jobless claims fell for the 2nd straight week as labor remains strong.

Yields were pushed higher at the front end of the curve by Powell’s speech, but yields in the belly and long end of the curve fell, reversing what had been a steady grind higher over the previous five weeks.

Growth stocks were the main beneficiary of the yield curve’s twist, as the reversal eased some of the recent pressure on P/E multiples. Cyclicals and defensives lagged. Blowout earnings from tech bellwether Nvidia also helped boost demand for stocks related to the generative A/I theme, including the mega-caps that dominate the Nasdaq, extending to strong YTD outperformance of that index.

Albion’s Four Pillars:

Economy & Earnings

The US economy showed resilience in the first half of 2023, and Wall Street analysts expect full-year corporate earnings to be roughly flat y/y. Albion’s base case expectation is that the US economy will enter recession in the second half of 2023, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 19x 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 (Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.

Interest Rates

Rates rose dramatically in 2022 due to a sharp pivot in monetary policy, and have remained elevated in 2023 as progress on inflation has been slower than hoped. Fed Funds Futures now show a slight odds-on probability of one addition 25bp rate hike before year-end.

Inflation

After reaching 40yr highs in spring of 2022, inflation has moderated somewhat over the past 12 months. Goods inflation has fallen due to softening demand and excess inventory, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged.

Weekly Recap:

Stocks fell for the 3rd week in a row as a combination of rising rates and China growth concerns weighed on P/E multiples. US investors woke up Monday morning to a slew of weak July macro data coming out of China, as a long-simmering decline in the Chinese property sector showed signs of bleeding into the broader economy:

* Industrial production fell 70bp to +3.7% y/y vs. consensus of +4.3%

* Retail sales fell 60bp to +2.5% y/y vs. consensus of +4.0%

* Property investment fell deeper into contraction at -8.5% YTD

The People’s Bank of China responded to the weakening economy by cutting its benchmark 1y lending facility rate by 15bp, to 2.50%.

Meanwhile, rates continued to leak higher in the US as fresh macro data showed a continuation of recent trends, including a resilient consumer (July retail sales accelerated), weak manufacturing (Empire Manufacturing sank deeper into contraction territory), mixed signals in housing (starts and permits showed modest gains, but builders report a decline in buyer traffic), and a strong labor market (initial jobless claims fell after a bump higher the previous week). Finally, the Conference Board’s Leading Economic Index (LEI) fell for the 16th month in a row.

Rising nominal yields combined with stable longer-term inflation expectations have pushed real 10y US Treasury yields (nominal yield minus inflation breakevens) to their highest levels since late 2008 / early 2009, when the threat of deflation during the depths of the financial crisis caused long-term inflation expectations to collapse. Dislocated markets aside, the current ~2% real yield on the 10y is more comparable to the pre-GFC market environment that prevailed in the mid-2000s. See the Chart of the Week for a time series.

Albion’s “Four Pillars”:

Economy & Earnings

The US economy showed resilience in the first half of 2023, and Wall Street analysts expect full-year corporate earnings to be roughly flat y/y. Albion’s base case expectation is that the US economy will enter recession in the second half of 2023, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 19x 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 (Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.

Interest Rates

Rates rose dramatically in 2022 due to a sharp pivot in monetary policy, and have remained elevated in 2023 as progress on inflation has been slower than hoped. Futures markets now imply that the Fed Funds overnight interest rate will remain unchanged at 5.25-5.50% until at least March of next year.

Inflation

After reaching 40yr highs in spring of 2022, inflation has moderated somewhat over the past 12 months. Goods inflation has fallen due to softening demand and excess inventory, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged.

Weekly Recap:

Stocks were mixed and bonds were mostly lower last week despite July inflation data that came in close to expectations:

* Headline CPI was +0.2% m/m and +3.2% y/y (slightly below consensus of +3.3%)

* Core CPI was +0.2% m/m and +4.7% y/y (in line with consensus)

* Headline PPI was +0.3% m/m and +0.8% y/y (10bp above consensus on both)

* Core PPI was +0.3% m/m and +2.4% y/y (also 10bp above consensus on both)

In addition, Friday’s preliminary August release of the University of Michigan’s Consumer Sentiment survey showed a 10bp decline in 1-year forward inflation expectations, from 3.4% to 3.3%, while longer term (5-10 year) expectations also declined by 10bp, from 3.0% to 2.9%.

Despite the relatively encouraging inflation outlook, US Treasury yields continue to be pulled higher by a combination of domestic supply technicals and the potential for shifting relative value versus Japanese Government Bonds (JGB’s) as the Bank of Japan relaxes its long-held policy of yield curve control. Yields moved higher across the curve last week as a result, sending most bond prices lower.

Stocks finished mixed against this backdrop. Idiosyncratic winners included energy stocks, which have been lifted by the rising tide in oil and gas prices over the past six weeks, and a handful of healthcare names (particularly Eli Lilly) that were the beneficiary of investor enthusiasm regarding the mass market potential of new weight-loss drugs. On the other side of the ledger, most technology stocks were lower on the week as rising rates impacted P/E multiples for longer-dated growth companies.

Albion’s “Four Pillars”:

Economy & Earnings

The US economy showed resilience in the first half of 2023, and Wall Street analysts expect full-year corporate earnings to be roughly flat y/y. Albion’s base case expectation is that the US economy will enter recession in the second half of 2023, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 19x 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 (Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.

Interest Rates

Rates rose dramatically in 2022 due to a sharp pivot in monetary policy, and have remained elevated in 2023 as progress on inflation has been slower than hoped. Futures markets now imply that the Fed Funds overnight interest rate will remain unchanged at 5.25-5.50% until at least March of next year.

Inflation

After reaching 40yr highs in spring of 2022, inflation has moderated somewhat over the past 12 months. Goods inflation has fallen due to softening demand and excess inventory, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged.

Weekly Recap:

Last week Fitch Ratings became the second credit rating agency to downgrade the sovereign rating of the United States one notch from AAA to AA+ (the first was S&P in 2011). While arguably of no real concern in terms of a direct impact on US borrowing costs, this move did dampen sentiment and may have contributed to lower stock and bond prices.

Meanwhile, the Treasury yield curve steepened last week due to a combination of supply technicals and macroeconomic data. At the front end of the curve, rates were lower on the week after dropping significantly on Friday thanks to a soft(ish) nonfarm payroll report. Futures markets discounted the probability of another rate hike this year, while 1y Treasury yields fell 8bp and 2y yields dropped 9bp.

Conversely, rates rose in the belly and long end of the curve thanks to the announcement of greater-than-expected supply of new borrowing from the US Treasury, which in turn contributed to P/E multiple compression, sending stock prices lower.

The most significant macro data last week was the monthly nonfarm payroll report from the Bureau of Labor Statistics. While unemployment remains near historic lows, the report was slightly softer than expected on balance:

* Change in nonfarm payrolls = +187k vs. consensus of +200k (net 2m revision -49k)

* U-3 Unemployment = 3.5% vs. previous month 3.6%

* U-6 Underemployment = 6.7% vs. previous month 6.9%

* Average hourly earnings = +0.4% m/m (prior month was also +0.4%)

* Average weekly hours = 34.3 (down 0.1 from prior month of 34.4)

Albion’s “Four Pillars”:

Economy & Earnings

The US economy showed resilience in the first half of 2023, and Wall Street analysts expect full-year corporate earnings to be roughly flat y/y. Albion’s base case expectation is that the US economy will enter recession in the second half of 2023, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 19x 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 (Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.

Interest Rates

Rates rose dramatically in 2022 due to a sharp pivot in monetary policy, and have remained elevated in 2023 as progress on inflation has been slower than hoped. Futures markets now imply that the Fed Funds overnight interest rate will remain unchanged at 5.25-5.50% until at least March of next year.

Inflation

After reaching 40yr highs in spring of 2022, inflation has moderated somewhat over the past 12 months. Goods inflation has fallen due to softening demand and excess inventory, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged.