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Weekly Recap:

Equities were mixed last week: rate-sensitive sectors (growth and real estate) struggled while shorter-duration, higher dividend-paying sectors (cyclicals and defensives) outperformed. Small and midcaps also outperformed thanks to their less growth-heavy sector weightings.

Normally one might expect that kind of returns distribution to be driven by rising rates, and at the front end of the curve that was certainly the case. In particular, an unexpected fall in weekly initial jobless claims at 228k (consensus =240k; prior week = 237k) pushed short rates higher and increased the odds that the Fed may still have two more rate hikes to go before year-end.

However, yields in the belly of the Treasury curve hardly budged, and long bond yields actually finished the week slightly lower, keeping the US Aggregate index flat on the week. Credit spreads continued their slow grind tighter, pushing corporate bonds prices up a bit.

Away from jobless claims, other economic news last week was mixed. Housing starts and residential building permits both eased back to 1.4mn annualized in June after a sharp rebound on May, but directionally it still appears that housing activity is on the upswing after hitting a trough around the end of 2022. And finally, the Conference Board’s US Leading Economic Index (LEI) fell sequentially for the 15th month in a row, and is at y/y levels that in the past have only been associated with imminent or in-progress recessions (see the Chart of the Week for a 60-year 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 19.5x 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 are currently pricing 1-2 additional 25bp rate hikes over the summer, with no rate cuts expected 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 and bonds rallied in unison last week as the US debt ceiling drama was resolved without a government default. Unlike the prior week, where gains were limited to a relative handful of A/I and chip-related stocks, last week’s move higher in stocks was broad based. All sectors in the S&P 500 finished in the green, with cyclicals and growth stocks leading the way while staples lagged the rally a bit.

Bonds rallied too, as whatever default premium had been baked into Treasury yields was quickly removed by investors. Public commentary from Fed officials favoring a June pause was also helpful, driving the odds of a 25bp hike next week from 70% at the end of the prior week to just 30% by Friday’s close. Credit spreads finished modestly tighter as well.

On the economic front, the main message from incoming data was that labor markets remain strong. JOLTS job openings reversed a recent trend towards normalization with a print of 10.1 million, ADP employment significantly exceeded expectations, and jobless claims were steady.

Meanwhile, the monthly jobs report from the BLS showed strong payroll gains, but also a modest uptick in the unemployment rate, a sequential decline in hours worked, and mild deceleration in the rise in average hourly earnings:

• Change in Nonfarm Payrolls = +339k (cons. est. +195k)
• Unemployment rate = 3.7% (prior month = 3.4%)
• Average weekly hours = 34.3 (prior month = 34.4)
• Average hourly earnings = +4.3% y/y (prior month = +4.4% y/y)

Albion’s “Four Pillars”

Economy & Earnings

The US economy enjoyed a strong second half of 2022, but growth has slowed in early 2023 and corporate operating margins have fallen as labor and input cost pressures bite. Albion’s base case expectation is that the US economy will enter recession in 2023, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 18x is above the long run average, suggesting that valuation could be a mild 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 in response to a sharp pivot in monetary policy, and have remained elevated in 2023 as progress on inflation has been slower than hoped. Futures markets are currently pricing one additional 25bp rate hike over the summer, with the possibility of rate cuts near the end of the 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 saw a concentrated rally in technology stocks after GPU manufacturer Nvidia provided an updated forecast for revenue growth that far exceeded analysts’ expectations. In particular, any stock that investors believed to be A/I- or semiconductor-related saw strong buying pressure. Meanwhile, most other companies and sectors finished the week lower despite slow-but-steady progress towards a debt ceiling deal over the course of the week.

Macro data was a bit less cooperative, however, particularly on the inflation front as the PCE Deflator came in higher than expected in freshly released April data:

• Headline PCE m/m = +0.4% (+0.3% cons est; +0.1% prior month)
• Headline PCE y/y = +4.4% (+4.3% cons est; +4.2% prior month)
• Core PCE m/m = +0.4% (+0.3% cons est; +0.3% prior month)
• Core PCE y/y = +4.7% (+4.6% cons est; +4.6% prior month)

Stubborn inflation sent rates higher on the week, particularly in the front end as investors priced in one additional 25bp rate hike over the summer. Futures markets are fairly evenly split as to whether that hike will occur at the June or July meeting, while expectations of rate cuts in the back half of the year are gradually waning.

Other macro data released last week mostly suggested a resilient economy. Personal incomes and spending rose more than expected in April, as did durable goods orders. In addition, there was a modest rebound in the University of Michigan’s consumer sentiment gauge, with assessment of current conditions improving while consumers’ near and longer-term inflation expectations fell.

Albion’s “Four Pillars”

Economy & Earnings

The US economy enjoyed a strong second half of 2022, but growth has slowed in early 2023 and corporate operating margins have been gradually falling as labor and input cost pressures bite. Albion’s base case expectation is that the US economy will enter recession in 2023, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 18x is above the long run average. 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 below the long-run historical average.

Interest Rates

Rates rose dramatically in 2022 in response to a sharp pivot in monetary policy, and have remained elevated so far in 2023 as progress on inflation has been slow. Futures markets are currently pricing one additional 25bp rate hike over the summer, with the possibility of rate cuts in the back half of the 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:

Markets were volatile day by day last week as optimism around a debt ceiling deal ebbed and flowed. A strong two-day rally on Wednesday and Thursday eventually ran out of steam as it became clear that a deal was not going to take place before the weekend, leading to a small pullback on Friday. Still, all major US equity benchmarks finished solidly in the green, with growth stocks leading the way and defensive sectors firmly on the back foot.

Renewed appetite for risk assets was clearly reflected in fixed income markets as well. Bond prices fell as rates rose across the curve, and credit spreads tightened.

While not front and center on investors’ minds last week, macroeconomic data continued to paint a picture of a slowing US economy, albeit not universally. Signs of deceleration included:

• Empire Manufacturing sunk back into contraction territory at -31.8
• Philly and New York Fed regional surveys remained in the contraction zone
• Existing home sales, residential building permits, and mortgage applications all fell
• Initial jobless claims (242k) remain elevated relative to recent cycle lows
• The Conference Board’s Leading Economic Index (LEI) fell to a fresh cycle low

On a more positive note:

• Retail sales for April (+0.4% m/m) rebounded after falling in March
• The National Association of Home Builders market index rose to 50 (neutral)
• Industrial Production rose 0.5% in April, while Capacity Utilization increased +30bp

Albion’s “Four Pillars”:

Economy & Earnings

The US economy enjoyed a strong second half of 2022, but growth has slowed in early 2023 and corporate operating margins have been gradually falling as labor and input cost pressures bite. Albion’s base case expectation is that the US economy will enter recession in 2023, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 18x is above the long run average. 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 below the long-run historical average.

Interest Rates

Rates rose in 2022 in response to a sharp pivot in monetary policy, but have been steady to slightly lower across most of the curve so far in 2023. Futures markets are currently pricing a Fed pause after 500bp of hikes over the past 14 months, with the possibility of rate cuts in the back half of the 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:

Most stocks and bonds were modestly lower last week despite April CPI numbers coming in a tiny bit better than expected. While the m/m change in both core and headline CPI registered at +0.4%, the y/y change in headline CPI (the most commonly cited inflation figure) fell to 4.9%, ending a 23-month period where inflation was greater than 5% on a y/y basis (the last sub-5% print was in April of 2021).

Notably, the opposing trends in inflation (lower) and overnight interest rates (higher) have brough the two together, creating an environment where nominal yields on cash equivalents (money market funds, short term Treasuries, and CD’s) equal or exceed inflation. Positive real yields on cash have been a rare occurrence in the period since the 2008/09 financial crisis, occurring only briefly in 2019 after the conclusion of the Fed’s previous hiking cycle. See the Chart of the Week for a time series of prime money market fund (SWVXX) yield versus the y/y change in CPI.

Despite the trend lower in inflation, investors’ expectations of near term rate cuts waned a bit last week, and the Treasury curve shifted higher. Meanwhile, risk assets continue to be impacted by anxiety around the debt ceiling deadline, with stocks and commodities finishing lower while credit spreads widened.

A notable exception to the general market weakness was Google, which rocketed higher by more than 11% last week after the company showcased a number of advancements in its use of generative A/I at the company’s annual “Google I/O” developer conference. Google’s surge was enough to pull the Comms sector into positive territory on the week, and helped the Nasdaq eke out a small gain as well.

Albion’s “Four Pillars”:

Economy & Earnings

The US economy enjoyed a strong second half of 2022, but corporate operating margins have been gradually falling as labor and input cost pressures bite. Albion’s base case expectation is that the US economy will enter recession in 2023, putting downside pressure on earnings.

Valuation

The S&P 500’s forward P/E of 18x is above the long run average. 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 single digits.

Interest Rates

Rates rose in 2022 in response to a sharp pivot in monetary policy but have mostly fallen (except for the very front end) so far in 2023. Futures markets are currently pricing a Fed pause after 500bp of hikes over the past 14 months, with the possibility of rate cuts in the back half of the year.

Inflation

After reaching 40yr highs in spring of 2022, inflation moderated in the second half of the year. 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.