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Weekly Market Recap – February 16, 2024

Weekly Recap:

Stocks were mixed and bond yields rose after higher-than-expected CPI and PPI prints dampened investors’ enthusiasm regarding near term interest rate cuts:

* Headline CPI was +0.3% m/m & +3.1% y/y (consensus +0.2% m/m & +2.9% y/y)

* Core CPI was +0.4% m/m & +3.9% y/y (consensus +0.3% m/m & +3.7% y/y)

* Headline PPI was +0.3% m/m & +0.9% y/y (consensus +0.1% m/m & +0.6% y/y)

* Core PPI was +0.5% m/m & +2.0% y/y (consensus +0.1% m/m & +1.6% y/y)

Bigger picture, the disinflationary trend largely remains in place, but as expected the final leg of the journey back to the Fed’s 2% target is proving to be a somewhat slow and bumpy ride.

In response, futures markets pushed the first “odds on” FOMC rate cut from May to June. Yields rose across the Treasury curve, particularly in the front end as market participants once again recalibrated their expectations regarding the path toward monetary policy normalization.

Meanwhile, credit spreads tightened yet again, cushioning the downside in US corporate bonds.

Finally, equity performance was strictly ordered by duration last week, with technology and other growth stocks lagging while dividend-paying cyclicals and defensives were better. Energy stocks also got a boost from rising oil prices as tensions rose in the middle east amid signs of escalation in the conflict between Israel and Hamas. Small and midcap benchmarks outperformed large caps on the week, mostly due to differences in industry composition.

Chart of the Week: Headline CPI and 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 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 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 likely 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 November/December of 2023.

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.

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Weekly Market Recap – February 9, 2024

Weekly Recap:

Stocks were better and bond yields rose in what was for the most part a slow week for macro data. The most consequential release was undoubtedly the ISM Services Index (53.4), which came in higher than expected across the board in January, particularly the Employment (50.5) and Price Paid (64.0) components. With services being the primary source of inflation in the US economy at this point, the strength in this print was notable and will certainly influence the Fed’s thinking.

In financial media the headline was undoubtedly “S&P 5,000”, as the S&P 500 closed above this tidy (but ultimately irrelevant) milestone for the first time ever on Friday. As was the case last year, the gains in the S&P have been very unevenly distributed so far in 2024. Once again, large cap technology stocks have driven a sizeable portion of the index’s overall performance. While the market-cap weighted S&P 500 has thus far delivered a YTD total return of 5.5%, the equal-weighted version of the index has put up a return of just 0.8%.

Bond yields rose once again last week, as market participants continue to lower their assumptions about the quantity and timing of rate cuts in 2024. Relative to year-end levels, Treasury yields are now 20-35 basis points higher across the curve, with long bond yields feeling the brunt of the selling pressure. Credit spreads were stable last week and remain at tight levels relative to long run averages.

In commodity news, oil prices spiked at the end of the week after Israel rejected a cease-fire and hostage return offer from Hamas. However, natural gas prices are at multi-year lows, and gasoline prices at the pump have only edged a few cents higher in the US after falling significantly in Q4, to the benefit of consumer confidence.

Chart of the Week: ISM Services Index

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 November/December of 2023.

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.

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Weekly Market Recap – February 2, 2024

Weekly Recap:

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.

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Monthly Market Recap – January 2024

January 2024 Recap:

Inflation

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
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Weekly Market Recap – January 26, 2024

Weekly Recap:

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.

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Weekly Market Recap – January 12, 2024

Weekly Recap:

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:

* Headline CPI was +0.3% m/m (consensus = +0.2%; prior month = +0.1%)

* Headline CPI was +3.4% y/y (consensus = +3.2%; prior month = +3.1%)

* Core CPI was +0.3% m/m (consensus = +0.3%; prior month = +0.3%)

* Core CPI was +3.9% y/y (consensus = +3.8%; prior month = +4.0%)

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.

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Weekly Market Recap – January 5, 2024

Weekly Recap:

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)

* U-3 Unemployment Rate 3.7% (consensus 3.8%; prior month 3.7%)

* Average hourly earnings +4.1% y/y (consensus +3.9%; prior month +4.1%)

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.

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Weekly Market Recap – December 15, 2023

Weekly Recap:

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.

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Weekly Market Recap – December 8, 2023

Weekly Recap:

Stocks and bonds were mixed last week, as the macro calendar built towards the highly anticipated monthly jobs report from the Bureau of Labor Statistics. With U3 unemployment dipping 20 basis points to 3.7%, the Sahm Rule (trailing 3m average U3 rising at least 50bp above the 12 month low) was not triggered, suggesting that the US economy remains in expansion mode. Highlights from the jobs report include:

* Nonfarm payrolls = +199k (consensus = +185k; prior month = +150k)

* U3 unemployment = 3.7% (consensus = 3.9%; prior month = 3.9%)

* U6 underemployment = 7.0% (prior month = 7.2%)

* Average hourly earnings rose 0.4% m/m and 4.0% y/y

* Labor force participation rate rose 10bp to 62.8%, equaling post-pandemic highs

In fixed income, the yield curve inversion deepened, with short yields rising in the wake of the stronger-than-expected jobs report as market participants recalibrated their expectations regarding the timing and pace of a Fed rate cutting cycle. Meanwhile, long bond yields drifted lower over the course of the week only rose a few basis points on Friday. Corporate credit spreads were steady at tight levels.

Stocks were mixed, with most cyclicals and defensives slightly lower while tech stocks benefitted from falling discount rates and renewed A/I enthusiasm thanks to the release of Gemini from Alphabet (Google). Energy stocks lagged again as oil prices fell by nearly $3/barrel during the week. International stocks were mixed as well, with D/M finishing higher while E/M benchmarks were pulled lower by weakness in Chinese equities. China’s economy is suffering from weakening demand, and is struggling to contain the fallout from turmoil in the property sector. The MSCI China index closed at YTD lows on Friday, and is off nearly 60% from the all time highs set in early 2021.

Chart of the Week: USD GDP Growth with Consensus Estimates (q/q, annualized)

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 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 have remained elevated in 2023 as the Fed remains committed to fighting inflation. Futures markets imply almost no chance of another 25bp rate hike, and that the Fed will begin cutting rates in mid-2024.

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.

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Weekly Market Recap – December 1, 2023

Weekly Recap:

Much like the rest of the month, the last week of November (and the first day of December) featured rapidly falling bond yields, which in turn drove stocks higher via P/E multiple expansion. By week’s end, 10-year Treasury yields had fallen nearly 80 basis points from their recent cycle high on October 19th. During that time, the bond market narrative has shifted dramatically. In mid-October, investors fretted that the deluge of supply coming from the US Treasury would overwhelm a shrinking buyer base, pushing yields even higher. Since then, fixed income investors have embraced the disinflationary trend, and have been encouraged by public statements from FOMC members that appear to suggest that the hiking cycle is over (despite occasional comments from Jerome Powell that are clearly intended to leave the door open just a crack).

As discount rates have fallen, P/E multiples have expanded, pushing stock prices sharply higher. Cyclicals (ex energy) were the biggest beneficiary last week, perhaps owing some of their strength to an upwardly revised Q3 GDP print (to 5.2% q/q annualized) that may have increased some investors’ confidence that a soft landing had already been achieved (note that Albion does not share this view). See the Chart of the Week for annualized GDP growth in recent quarter along with consensus estimate through the end of 2024.

October PCE data released last week reinforced the disinflationary trend, with headline PCE flat sequentially while core (ex food & energy) PCE was just 0.2% m/m. On an annualized basis, the last six months worth of Core PCE data point to a real time inflation rate of just 2.5%. The past three months of core PCE are even more sanguine at just 2.35% annualized.

Chart of the Week: USD GDP Growth with Consensus Estimates (q/q, annualized)

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 late 2023 / early 2024, 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 (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 very low odds of another 25bp rate hike, and that the Fed will begin cutting rates in mid-2024.

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 excess inventory, while services inflation remains elevated, in part due to shelter costs which are somewhat lagged