Most stocks and bonds had a reasonably good week, despite disappointment (in some corners) regarding the prospects of a March rate cut.
The most important event of the week was unquestionably the January FOMC meeting, at which Fed Chair Jerome Powell made it very clear (within the constraints of Fed-speak) that the committee does not believe that economic conditions will justify a March cut. Several prominent Wall Street economists scrambled to update their forecasts (Goldman, BofA, and Barclays were all out the next morning with May as their new target), while Fed Funds Futures investors quickly repriced the odds of a March cut to a 4-to-1 long shot.
Otherwise, macro data released last week was strong, including:
* Conference Board Consumer Confidence rose to 114.8, a 2+ year high
* Manufacturing PMIs from ISM (49.1) and S&P (50.7) rose to 15m highs
* JOLTS Job Openings rose back to 9 million
* The BLS jobs report showed +353k NFPs, and 4.5% y/y wage growth
While the front end of the curve remains pinned, rates in the belly and long end finished the week lower, allowing most bonds to see solid price gains on the week. Credit spreads edged slightly wider, perhaps showing some fatigue after the strong rally in credit over the past 3 months.
Most equities were also better on the week. The energy sector was an exception, as oil prices fell markedly on reports of a cease-fire between Israel and Hamas.
Chart of the Week: Net US Nonfarm Payrolls Added
Albion’s “Four Pillars”:
Economy & Earnings
The US economy was resilient last year, and Wall Street analysts expect full-year 2023 corporate earnings to be roughly flat y/y versus 2022. Analysts are forecasting approximately 10% 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 20x 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 (Eq Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.
Interest Rates
Futures markets imply that the Fed will cut overnight interest rates several times in 2024, most like beginning mid-year. The belly and long end of the curve have already priced in a rate cutting cycle, with yields falling more than 100bp in the past few months.
Inflation
After reaching 40yr highs in mid-2022, inflation has moderated significantly over the past 18 months. Goods inflation has fallen due to softening demand and supply chain normalization, while services inflation remains somewhat elevated, in part due to heavily lagged shelter costs.
Data released in January showed that as 2023 drew to a close, inflation was generally tame, but not quite tame enough for the Fed to declare victory. The Core PCE Deflator (the Fed’s preferred inflation metric) stood at +2.9% y/y as of the end of December, the first sub-3% print since March of 2021. Meanwhile, Core CPI printed at +3.9% y/y, also the lowest since the first half of 2021. While these figures are directionally encouraging, the pace of disinflation has slowed in recent months, and both metrics remain solidly above the Fed’s long term 2% target.
Monetary Policy
The main event for market participants in January was the FOMC meeting that concluded on Wednesday the 31st. While no one expected a change in overnight interest rates out of that meeting, everyone was interested in getting an answer to the question of “will they or won’t they” begin cutting rates at the March meeting. The answer, delivered as clearly as can be given the constraints of Fed-speak, is no. Jerome Powell made it very clear that the committee does not anticipate that economic conditions will justify the start of a rate cutting cycle in March.
Economy
Outside of the manufacturing sector, which mostly remains in contraction, economic data released in January was solid. Consumer confidence continues to climb, thanks in part to falling inflation that everyone can see at the gas pump. Lower mortgage rates stimulated activity in the housing sector. And the labor market remains strong: jobless claims are low (~200k initial claims per week), open jobs are plentiful (9 million per the most recent JOLTS report), and job creation continues to chug along (216k nonfarm payrolls added in the most recent monthly BLS job report).
Bond Market
The yield curve steepened in January, with 2y yields falling slightly while yields in the belly and (especially) the long end rising a bit. Longer term yields continue to be challenged by the outlook for US budget deficits, making them somewhat more attuned to the election cycle (and especially growing populist impulses across the political spectrum) that will unfold over the course of 2024. Most bond prices finished the month lower, although a contraction in credit spreads (to levels that are nearing historic tights) helped to cushion the downside in corporate bonds.
Stock Market
US large caps enjoyed a solid first month of 2024, but as was the case last year the gains were concentrated in a comparatively small number of individual stocks. Cyclicals and defensives were much more of a mixed bag, resulting in underperformance of small and midcap benchmarks that have greater exposure to such industries. International markets were mixed as well, with emerging market indices especially weak due to sharp underperformance in Chinese equities.
January 2024 S&P 500 Total Return by Sector
Albion’s “Four Pillars”:
Economy & Earnings
The US economy was resilient last year, and Wall Street analysts expect full-year 2023 corporate earnings to be roughly flat y/y versus 2022. Analysts are forecasting approximately 10% 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 20x 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 (Eq Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.
Interest Rates
Futures markets imply that the Fed will cut overnight interest rates several times in 2024, most like beginning mid-year. The belly and long end of the curve have already priced in a rate cutting cycle, with yields falling more than 100bp in the past few months.
Inflation
After reaching 40yr highs in mid-2022, inflation has moderated significantly over the past 18 months. Goods inflation has fallen due to softening demand and supply chain normalization, while services inflation remains somewhat elevated, in part due to heavily lagged shelter costs.
Albion’s Dashboard of Key Leading Economic Indicators as of 01/31/24
A combination of solid economic data, a cool(ish) inflation print, and subdued rate volatility allowed stocks to post solid gains last week.
Beginning with the economy, S&P Global’s US Manufacturing (50.3) and Services (52.9) PMIs both surprised to the upside in December. The manufacturing print was the highest in 15 months, and only the 2nd time above 50.0 (expansion territory) during that period. Meanwhile, durable goods orders (ex transports) rose +0.6% sequentially in the preliminary December reading, while the prior month was revised higher by 10bp to +0.5%. Personal spending of +0.7% m/m in December also bested consensus estimates. Mortgage applications and pending home sales rose, as the recent moderation in rates continues to filter through to the housing market. Finally, labor market indicators remained strong, with little change in jobless claims.
Those trends all contributed to a strong initial estimate of Q4 US GDP growth, which registered at +3.3% q/q on an annualized basis, far outpacing the +2.0% consensus. The US economy enjoyed a solid growth trajectory in the second half of 2023, pushing full-year GDP growth to +2.5% after sub-trend growth during the first part of the year. Consensus estimates for 2024 GDP stand at +1.5%. See the Chart of the Week for quarterly annualized GDP growth along with next year’s consensus.
On the inflation front, December’s Core PCE Deflator (the Fed’s preferred inflation gauge) registered at +0.2% m/m in December, and at just +2.9% on a y/y basis. This marks the first sub-3% y/y Core PCE print since March of 2021, ending a streak of 32 consecutive months above 3%. Bond markets took this print in stride, having largely priced in the Fed’s ultimate victory over inflation. Equities welcomed the rate stability, as the forward P/E on the S&P 500 expanded to 20x consensus 2024 earnings.
Chart of the Week: US GDP Growth (q/q, annualized)
Albion’s “Four Pillars”:
Economy & Earnings
The US economy was resilient last year, and Wall Street analysts expect full-year 2023 corporate earnings to be roughly flat y/y versus 2022. Analysts are forecasting approximately 10% 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 20x 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 (Eq 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 remained elevated in 2023 as the Fed continued fighting inflation. Futures markets imply that the Fed will cut rates significantly in 2024, possibly beginning as early as the March meeting.
Inflation
After reaching 40yr highs in spring of 2022, inflation has moderated significantly over the past 18 months. Goods inflation has fallen due to softening demand and supply chain normalization, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged.
“Consider it as sculpting a financial architecture…”
Embarking on the journey of retirement is akin to laying the foundation for a fresh chapter in your financial life, where the structure of your income becomes pivotal. In this exploration, we’ll delve into the art of income planning beyond retirement—a strategic composition not just to make your money last but to construct a financial foundation for a lifetime. Consider it as sculpting a financial architecture to support your lifestyle and aspirations.
Understanding the Blueprint of Retirement Income:
“The initial step is to decipher the blueprint of your income sources.”
In the realm of retirement income planning, the initial step is to decipher the blueprint of your income sources. Begin by evaluating and documenting your existing and potential retirement income streams, including pensions, Social Security benefits, and withdrawals from your investment portfolio. This exercise transforms your blueprint from an idea into a written account, outlining the contours of your retirement foundation.
Key Considerations:
Pensions and Social Security: Scrutinize the reliability and sustainability of these income sources, weighing factors like lump-sum versus annuity payout for pensions and potential changes in Social Security regulations or benefit age.
Investment Portfolio: Consider how your investments will contribute to your retirement income. Evaluate the risk profile of your current portfolio and its role in shaping your overall financial structure.
Building a Structure of Sustainable Income:
“This exercise transforms your blueprint from an idea into a written account, outlining the contours of your retirement foundation.”
Once the blueprint is clear, the subsequent step is to construct a plan for sustainable income. During this phase, you are crafting a framework for your retirement income that not only covers your basic needs but also adapts to the dynamic nature of your financial landscape.
Strategies to Consider:
Systematic Withdrawals: Establish a plan for systematic withdrawals from your investment portfolio, ensuring a steady income flow. There are various withdrawal strategies worth considering; this one proves relatively easy to implement.
Tax-Efficient Strategies: Explore tax-efficient methods to optimize your income. This may involve considering Roth conversions, strategic charitable giving, or other approaches to minimize tax implications. Remember that reducing your total lifetime tax payments holds more impact for your financial plan than merely reducing your current year tax liability.
Fine-Tuning for Resilience:
“During this phase, you are crafting a framework for your retirement income…”
Just as architects prioritize resilience in building design, your retirement income structure needs fine-tuning for resilience. Integrate risk management strategies to guard against unforeseen challenges and disruptions. The focus should be on the goals you’ve defined for your retirement, without succumbing to the uncertainties of the world around you.
Resilience Strategies:
Emergency Fund: Maintain an emergency fund to cover unexpected expenses and ensure a buffer against financial uncertainties.
Insurance: Review insurance strategies to ensure alignment with your needs, providing a safety net for unexpected healthcare or other significant expenses you prefer not to bear.
Adapting to Change:
“Regularly reviewing and adjusting your plan ensures resilience against evolving personal goals and unforeseen events.”
Bestselling author Morgan Housel encapsulates the transformative nature of time with his statement, “World War II began on horseback in 1939 and ended with nuclear fission in 1945.” In the realm of retirement, where uncertainties abound, one undeniable certainty is change. Your retirement structure should be dynamic, embodying a key principle of financial planning—adaptability. Regularly reviewing and adjusting your plan ensures resilience against evolving personal goals and unforeseen events.
Adaptability Strategies:
Regular Reviews: Schedule periodic reviews to assess the effectiveness of your income plan and make adjustments as needed.
Flexibility: Build flexibility into your plan to accommodate changes in lifestyle, healthcare needs, or financial goals.
The Completed Project:
“Be sure to carefully reflect on the structure you have built, ensuring proper alignment and cohesion with your aspirations and financial goals.”
As you conclude the process of crafting your foundation for lasting income in retirement, be sure to carefully reflect on the structure you have built, ensuring proper alignment and cohesion with your aspirations and financial goals. In this endeavor, you’re not only securing your own financial future but also building a legacy to endure for future generations.
Just as a completed architectural project stands as a testament to the vision and skill of its creators, your retirement income structure becomes a tangible representation of your financial success. It’s a timeless blueprint, offering enduring stability to enrich your retirement journey and providing a solid foundation for the chapters that follow. As you navigate the complexities of retirement income planning, you’re not just securing your own well-being, you’re shaping a legacy that will resonate for years to come, ensuring that your financial story stands strong against the test of time.
“You’re shaping a legacy that will resonate for years to come, ensuring that your financial story stands strong against the test of time.”
It is strongly advised to seek counsel from a qualified financial adviser, tax professional, or attorney before implementing any strategy or acting upon any recommendation outlined herein. Albion Financial Group disclaims any responsibility for the consequences of individuals’ decisions based on the information presented and encourages thorough consultation with a financial professional to ensure the appropriateness of any financial decisions made in consideration of personal circumstances and financial objectives.
Rates moved lower and stocks rallied last week, despite a slightly higher-than-expected December CPI print that was released before the open on Thursday:
Friday’s PPI (Producer Price Index) inflation print was a bit more favorable, with the headline index showing m/m deflation for the 3rd consecutive month and printing at just +1.0% y/y. The trend in PPI over the course of 2023 clearly confirms the anecdotal evidence provided by company management teams during earnings calls: input cost pressures, which led the move higher in CPI in 2021/22, have largely abated at this point and have helped pull CPI lower in the second half of 2023. See the Chart of the Week for a comparison of the y/y change in CPI and PPI over the past several years.
On the back of these inflation updates, investors pushed yields lower across the Treasury curve, particularly in the front end as the implied odds of a March rate cut rose by ~10% on the week. Credit spreads rallied after wobbling a touch during the first week of 2024, resulting in strong returns for corporate bonds.
Finally, equities benefitted from falling rates and rising risk appetite. Rate-sensitive growth stocks were particularly strong, with most large cap tech names posting solid gains on the week, driving outperformance in the Nasdaq. Meanwhile the S&P 500 rose to within 13 points (~0.3%) of its all-time high set on the first trading day of 2022.
Chart of the Week: CPI vs. PPI (y/y change)
Albion’s “Four Pillars”:
Economy & Earnings
The US economy was resilient last year, and Wall Street analysts expect full-year 2023 corporate earnings to be roughly flat y/y versus 2022. Analysts are forecasting approximately 10% 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 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 (Eq 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 remained elevated in 2023 as the Fed continued fighting inflation. Futures markets imply that the Fed will cut rates significantly in 2024, beginning at the March meeting.
Inflation
After reaching 40yr highs in spring of 2022, inflation has moderated significantly over the past 18 months. Goods inflation has fallen due to softening demand and supply chain normalization, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged.
After a banner 2023 across most major asset classes (equities, bonds, cash, and real estate), the first week of 2024 proved to be far less kind to investors. Stronger-than-expected labor market data put a damper on some of the enthusiasm around the idea of a March rate cut, which in turn had implications for bonds yields, discount rates, and stock prices.
On Thursday, ADP reported a net employment change of +164k payrolls, exceeding consensus estimates of +125k, suggesting that American businesses are still hiring new workers at a respectable pace. Meanwhile, weekly initial jobless claims for the final week of December fell to 202k, one of the lowest prints since January.
Then on Friday, the monthly jobs report from the BLS painted a similar picture:
* December net nonfarm payrolls +216k (consensus +175k; prior month 173k)
As a result, futures markets trimmed ~30% from the odds of a March rate cut – what had been priced as a near certainty at the end of 2023 turned into a 70/30 proposition by Friday’s close. The Treasury yield curve responded in kind, with rates backing up roughly 15 basis points in a mostly parallel shift higher.
Higher risk free rates were too much for equities to withstand, so stock prices went lower as well. Rate sensitive sectors were the hardest hit, including many of 2023’s high flying technology and other growth stocks, as well as real estate. That said, many cyclicals and defensive names were relatively resilient. As a result, the Dow registered a smaller decline than the S&P 500, which in turn held in better than the Nasdaq.
Chart of the Week: Net Nonfarm Payrolls Added
Albion’s “Four Pillars”:
Economy & Earnings
The US economy was resilient last year, and Wall Street analysts expect full-year 2023 corporate earnings to be roughly flat y/y versus 2022. Analysts are forecasting approximately 10% 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 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 (Eq 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 remained elevated in 2023 as the Fed continued fighting inflation. Futures markets imply that the Fed will cut rates significantly in 2024, beginning at the March meeting.
Inflation
After reaching 40yr highs in spring of 2022, inflation has moderated significantly over the past 18 months. Goods inflation has fallen due to softening demand and supply chain normalization, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged.
For the last year and a half Albion has been sponsoring children at the Woodrow Wilson school, a Salt Lake City elementary school where 90% of the students qualify for food aid. Each month in conjunction with the Utah Food Bank we fill grocery bags for the children to take home to their families.
The students are just like you’d expect from a group of youngsters. Curious, energetic, funny, loud, silly, and occasionally contemplative. The food makes a significant difference for them and their families. For us it highlights the similarities among all of us. Regardless of economic circumstance most of us hope to have strong and caring relationships with our family and friends and live in a world where we are safe and find fulfillment while earning a reasonable living. Most of us do strive to get along with our neighbors despite differences of opinion we may have. You wouldn’t know that by reading the headlines. A recent sampling (with names removed) includes:
“Presidential Candidate augers divisive year in angry Christmas rant”
“2024 could bring a radical upending of the global order”
“The Supreme Court could correct Politicians’ huge mistake”
“With support fading and corruption building, will politician quit the race?”
“National anthem kneeler cancels Christmas and gift giving”
“Campus antisemitism finally gets its reckoning after students cheer terrorism”
From these headlines, and hundreds more like them, one might surmise that our overriding emotions are anger and fear. Yet that’s not the case. Yes, there is anxiety and anger in the population. And yes, unfortunately some of the most prominent voices feel they benefit by stoking anger, resentment and fear. Yet the facts show a different story.
Per FBI data violent crime fell 8% in the third quarter of 2023 compared to the same quarter last year and property crime fell 6.3% to its lowest level since 1961. But the dire headlines do work. Per Gallup 92% of Republicans, 78% of Independents and 58% of Democrats believe crime is rising.
We hear a lot about unemployment. Some choose to focus on job losses and high unemployment while others are focused on job creation. The current unemployment rate is 3.7% which is close to the low end of the long-term historical range. That’s impressive particularly in light of the rise in interest rates over the last several quarters. However despite high employment and consistent economic growth over half of us think the economy is getting worse, per a recent CNN poll.
Misleading headlines can be found regarding virtually any quantifiable measure. Why do we bring this up in an Albion letter? To highlight that in the work we do we must look past the headlines to what the underlying data tells us is actually happening. While there are clearly challenges in the world, the economic outlook has several bright spots. The Federal Reserve effort to rein in inflation is working. Higher interest rates, while clearly slowing economic activity, have not tipped us into a recession.
Consumers have remained resilient as spending has held up even in the higher rate environment. Companies continue to innovate and in many cases continue to show solid year-over-year earnings growth. Our professional goal for 2024 is to continue to scour the many opportunities to invest in what is working in the world and build and manage portfolios around those bright spots. Our personal task is to see the humanity in everyone and do what we can with our family, friends, colleagues and peers to ratchet down the temperature that headlines work to inflame. We wish you all a peaceful and prosperous new year.
Albion Financial Group is an SEC registered investment advisor. The information provided is intended solely for educational purposes and should not be construed as an offer or solicitation for the purchase or sale of any particular securities product, service, or investment strategy. Past performance is not indicative of future performance.
What does it mean to have humility? Classically defined, it is “a feeling or attitude awarding no special standing that makes you better than others.” As we close out the year, there are many lessons 2023 can teach us. Perhaps most salient is the concept of humility, especially relating to financial markets. Sour moods festooned the investment landscape as the year began. Inflation was high, interest rates were rising, stocks (and bonds) had just closed out a tough year, and recession was expected by most. Fast forward twelve months, as the year closes inflation is lower, rates have peaked, stocks (and bonds) logged solid returns, and the US has so far avoided recession. On the latter, while our process is thorough, I got it wrong in 2023. But it’s fanciful to expect that we’ll get everything right. Rather the aim is simply to go to bed a little smarter than when we woke up. To be lifelong learners and compound our knowledge. Fortunately, our toil and tenets position us to do just that.
We lost the venerable Charlie Munger this year. For over six decades Charlie was Warren Buffett’s sage right-hand at Berkshire Hathaway. He used to say, “we try to arrange our affairs so that no matter what happens we’ll never be sent ‘back to go,’” [Monopoly board game reference]. At Albion, we manage money under a similar belief. We don’t speculate. We invest. We don’t bank on short run forecasts when building portfolios. We take a long-term view. Indeed, an investment strategy shouldn’t hang on getting macro and market calls correct, and any such projections must carry a sizable dollop of humility. In practice, this means portfolio execution is incremental as opposed to extensive. Again, avoiding ‘back to go.’ This conduct is core to our investment philosophy. Adhering to these principles, plus sound investment selection, work together to deliver laudable risk-adjusted returns over time. Knowing the future is impossible. Accepting this is the first step to becoming less fragile and more adaptable. Instead, we pursue strategies that can survive whatever may occur.
Now, let’s review the fourth quarter.
The October through December period saw a continuance of the post pandemic expansion. GDP was (very likely) somewhat higher, the labor market is healthy, and consumer demand endures. Meanwhile, as we’ve anticipated, inflation is now about 3% (sub-3% by some measures!) and the Fed has clearly communicated that they’re done hiking rates. On balance, economic and market conditions sit somewhere between favorable and improving. This sent equities bounding higher. Concurrently, business profits – the lifeblood of stock prices – have perhaps bottomed if we avoid recession. That last piece is critical; we’ll revisit in a moment. A ding against the quarter was the awful Israel / Hamas war that broke out on October 7th. While markets, including energy, have taken the turmoil in stride, the human cost has been immense.
The overall good vibes sent valuations higher. The S&P 500 now goes for about 21.5x trailing earnings and 19.5x 2024 estimates. Not cheap, especially against yields that, despite the recent drop, are near multi-year highs. It’s also not wildly expensive. Profit growth for the whole of 2023 will settle in slightly better than flat (versus 2022) and growth expectations for 2024 infer an impressive +12% stride. And it’s here where the question of recession / no recession matters most. As for Wall Street’s big picture 2024 outlook? The consensus is now (unsurprisingly) cheerful. Economists and strategists expect a decent year for stocks (i.e., building on ’23 gains) and no recession. Our outlook? Unhappily we still see elevated risk of a mild recession. Yes, the economy has been resilient. But just because a slump hasn’t happened yet doesn’t mean it won’t. The business cycle always looks good just before it slides.
Generally, when you spike rates it has a negative impact that works with a lag. The idea that the Fed can take rates from 0% to nearly 5.5% with over a trillion in quantitative tightening (QT), over a short period of time, and that the economic pendulum will stop from strong growth to perfect growth without going negative doesn’t make sense to us. It would be ahistorical to expect that. There’s evidence of this in many of our preferred leading indicators, like LEI and the Treasury yield curve, as well as some early signs that strong employment and a robust consumer may be waning. Add to this those higher rates – plus the view that they may stay up here for a while (“higher for longer”) – and we still see heightened odds of recession near-term. We’re not out of the woods yet.
Despite this stance, with great humility and borrowing from Munger’s book of wisdom, we’re not betting the farm. Instead, the result of our uncharacteristically cautious macro outlook means we’ve added some “defense” to growth portfolios while, importantly, staying fully invested. We consider this approach to strike a functional balance between respecting short-term risks while staying true to our DNA as long-term investors. The big money is not in the buying and selling, but in the waiting. We will continue to manage your precious capital using a resolute investment philosophy, quality securities, and the best possible information. Many thanks for your trust in us. Happy New Year!
Albion Financial Group is an SEC registered investment advisor. The information provided is intended solely for educational purposes and should not be construed as an offer or solicitation for the purchase or sale of any particular securities product, service, or investment strategy. Past performance is not indicative of future performance.
The New Year is a good time to review your financial strategies to ensure they are aligned with your long-term goals – an expertise we bring to bear for our many client families. As the calendar turns and we look to the year ahead, what’s on your mind? What worries you? What excites you? Any hopes for the new year? As your wealth advisor, we endlessly ponder these questions. And while some items are more pleasant to contemplate, it can all feel daunting. We can’t know what the future will bring. But uncertainty is part of life, and each new year brings unexpected events that will impact who we are and how we think about the world.
Often, January is when we set goals for the coming year. But how when we can’t know exactly what’s ahead? Early 2020 threw us a global pandemic; 2021, a new US president; 2022 began with a Russian invasion of Ukraine: and in 2023 we jumped headlong into an artificial intelligence craze. Some developments are more consequential than others, but each brings unique haziness. What might 2024 hold?
The good news is we don’t actually need to know, though we must be ready for anything. It’s in our nature to believe we can think on our feet and quickly adapt to a changing environment. Unfortunately, that’s easier said than done. For instance, consider a soccer player receiving the ball without having analyzed the whole field. Focusing solely on the ball forces them to react without proper scope. Should they pass, shoot, or perhaps execute a Maradona turn? Whatever the decision, they must act. Despite ardently training for this moment, full preparedness is lacking because they’ve neglected their surroundings. As it turns out, context and the bigger picture matters.
Just as situational awareness is necessary for athletic success, it also greatly impacts financial outcomes. Indeed, if you aren’t keenly aware of the backdrop (including self-awareness which takes into account our own behavior and biases) your abilities alone may not be enough when the “financial ball” is passed and critical decisions need to be made. As you’ve likely heard us say, we believe in the importance of quality advising where financial success is the compounding result of a series of good decisions over time.
In soccer, it’s easy to know who wins – just look at who scored the most goals. Financial plans are different. What does it mean for you to win the “money game” you’re playing? Standard replies often center around the notion of financial independence, retirement, or a specific net worth. In fact, you could probably tell us precisely how much you’d like to make this year and what you’d like out of your investment portfolio(s), real estate, etc. Yet, viewing your finances in this way implies that money is a finite game with clear “winners” and “losers” bound by defined rules, limited resources, shared objectives, with cookie cutter endpoints and benchmarks. In truth, money and personal finance is an infinite game with no set finish line or buzzer. We must create individualized rules to offer our money utility. This personalization gives wealth purpose as we define both our goals and values. From there, we keep proactively “playing the game” based on this custom framework dedicated to your specific situation.
Bestselling finance author Morgan Housel has said the following about investing (one of the many areas of financial planning):
“It’s so easy to lump everyone into a category called ‘investors’ and view them as playing on the same field called ‘markets’. But most of the time you’re just a marathon runner yelling at a powerlifter. So much of what we consider investing debates and disagreements are just people playing different games and unintentionally talking over each other. A big problem in investing is that we treat it like it’s math where 2+2=4 for me and you and everyone – there’s one right answer. But it’s something closer to sports, where equally smart and talented people do things completely differently depending on what game they’re playing.”
Perhaps the single best game to impart the complexities of financial planning is three-dimensional chess with multiple opponents. Every move, every choice, creates additional uncertainties and interdependence that didn’t exist prior. And every move made by an opponent (e.g., externalities) creates the opportunity to reexamine one’s strategy. Financial plans can be continuously adjusted as each piece moves in the multi-dimensional chess game of life. Establishing an always monitored, ever evolving financial plan where we work together increases the odds of successful financial outcomes.
A central purpose of a financial plan is to help weather economic storms so that no matter what stage of life – accumulation, preservation, or distribution – you’re capable of absorbing and adapting to shifting environments. Let’s briefly revisit the notion of event-driven uncertainty. Think about the most recent significant global, national, or even local event. Did any of those catch you off guard, feeling unsure of your surroundings? Were you concerned about potential financial impacts? Going back to our soccer analogy, now imagine how would it feel to receive that “pass” amid the deafening stadium chaos, but this time you know exactly where you’re going. You’re prepared, situationally aware, and have filtered out the noise. Your coach’s (advisor’s) voice, the person with the best view of the entire playing field, comes through with great clarity and together optimal decisions are made.
Such arrangements bestow enhanced confidence to continue with the plan. When most are fearful, finding the signal in the noise provides us the refreshing opportunity to concentrate on other areas of life that truly bring joy and fulfillment. As your trusted wealth advisor, that’s the role we play. We’ll be here for you this year and beyond. Happy 2024!
Asset prices surged last week after a surprisingly dovish FOMC meeting. The committee kept overnight interest rates unchanged, as expected, but the updated Summary of Economic Projections (SEP) showed a significant change in the Fed’s thinking compared to the previous update in September. Gone was any notion of another 25bp rate hike, and more importantly, the SEP now implies that three 25bp rate cuts will take place in 2024. During the ensuing press conference, Fed Chair Jerome Powell confirmed that the committee has even begun discussing the potential timing of the first rate cut, suggesting that it may not be very far off.
The reaction of financial markets was swift and decisive. Fed funds futures markets immediately priced in a 25bp rate cut occurring at the March 2024 meeting, and raised the total amount of 25bp rate cuts in 2024 to six (markets to the Fed: “we’ll see your 3 rate cuts, and raise you 3 more!”). Meanwhile, yields fell by ~30bp across the Treasury curve, pushing the 10-year back below 4% for the first time since July. And at the same time, credit spreads tightened on the increase in risk appetite, driving corporate bond prices sharply higher. The turnaround in the US IG Corporate index over the past ~2 months has been remarkable, with mildly negative YTD returns from mid-October turning into a +8% YTD return as of Friday’s close.
Equity markets also reacted with enthusiasm, achieving broad-based gains that were most pronounced in sectors that have lagged this year, including cyclicals and small caps. The Dow Jones Industrial Average finished the week at a fresh all-time high, as did the Nasdaq 100, while the S&P 500 is within 2% of its record high. Among major US large cap benchmarks, only the Nasdaq Composite (a broader index than the Nasdaq 100) remains some distance (~8%) from its former peak.
Chart of the Week: US Large Cap Benchmarks Relative to 2021/2022 Highs
Albion’s “Four Pillars”:
Economy & Earnings
The US economy has shown resilience so far in 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 2024, putting downside pressure on earnings.
Valuation
The S&P 500’s forward P/E of 19.3x 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 (Eq 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 the Fed remains committed to fighting inflation. Futures markets imply that the Fed will cut rates significantly in 2024, beginning at the March meeting.
Inflation
After reaching 40yr highs in spring of 2022, inflation has moderated significantly over the past 18 months. Goods inflation has fallen due to softening demand and supply chain normalization, while services inflation remains elevated due to shelter costs and wage growth.
