Quarterly Letter Excerpt: Economy and Markets

If something cannot go on forever, it will stop. Economist Herbert Stein articulated this principle nearly forty years ago when discussing growing trade deficits with lawmakers. This humble insight can be applied to many situations. These days it feels as though post-pandemic economic strength will go on forever. Yet, we know that it won’t. It can’t. Our central theme of “normalization” is evident over the past eighteen months, and eventually the business cycle will overcorrect causing recession (not to be feared entirely as contractions cleanse the system). But that day isn’t today. Indeed, as we exit the first quarter the US economy is doing fine. Better than fine really, it’s quite robust. Consumer spending is resilient, jobs are plentiful, businesses are investing, and government budgets are expansionary. Real GDP grew by +2.5% in 2023, accelerating from the previous year, and estimates for Q1 sit around +2%. While these are backward-looking figures, more current information – like spending data from credit and debit card companies, retail sales, services PMIs, jobless claims, and even (recently) improving consumer confidence – suggests that momentum has carried into 2024.

But why the potency? The simple truth is economic strength is closely tied to jobs, which remains solid. And because the economy is strong that keeps the labor market strong as business profits support employment and wages. It’s a virtuous loop. And while signs of normalization (there’s that word again) in the labor are present, like softer demand for workers and increased supply, layoffs are low and hiring is steady. This balance is beneficial nurturing a more secure foundation. Until this situation changes, economic expansion should continue. The critical question is now, can we successfully move from too tight to well-adjusted in the jobs market without the pendulum swinging negative? Time will tell.

Inflation’s stride has also cooled over the past 20 months, from over 9% to roughly 3%. While much progress has been made, Jerome Powell asserts more work and greater confidence in the trend is needed to declare victory. We agree. The Fed’s target is ~2% and the “last mile” won’t be easy. Still, our long-held view endures – the contemporary war against inflation will be won.

Speaking of the Fed, last July we opined that the central bank was done hiking interest rates. Be it lucky or good, that view proved correct. We continue to reason that the Fed won’t need to raise rates further. We’ve gone from 0% to ~5.5%, a ton of credit tightening, and without a jump in unemployment. Job well done. The new Wall Street parlor game centers on how long the Fed will maintain its current stance before lowering rates. The answer hinges on the trajectory of the economy, employment, and inflation. Our best guess is the first cut will occur in the second half of this year.

All told, “soft landing” odds have increased compared to a year ago, a time when our preferred forward indicators signaled maximum caution. Several indicators have improved, meaning there’s been considerable diminution of risk over the past year. At this point we see recession odds at about a coin toss (down from over 80%). Historically, in any given year it’s ~15%.

In bonds, the action will likely be on the front end of the yield curve as big moves further out have mostly occurred. While things can move cyclically based on data and mood, structurally speaking longer duration securities appear sensibly priced for the current environment.

Meanwhile, firms are in good shape with profits holding steady in 2023. Despite “no growth”, revenues were higher last year due to an advancing economy and increasing prices. But so too were costs, in many cases more than revenues, resulting in compressed operating margins and inert profits. Looking ahead, analysts predict energetic earnings growth of +11% in 2024 and +13% for 2025, driven by a healthy economy and margin re-expansion. Those are high bars. From our perch, margins may have indeed bottomed if we can avoid a downturn. Thus the near-term direction of profits will largely hinge on the macroeconomy. Regardless, our primary attention is the longer-term outlook. Especially for those investments we own on your behalf. And here, we are optimistic for the years ahead.

For its part, the stock market has continued its momentum, driven by expectations of no recession and Fed rate cuts. Despite unease over the looming election, investor attitudes are (unsurprisingly) cheerful on the back of impressive recent performance. Moreover, the inflation problem is under control and geopolitics, while tense, sit more at a simmer than a boil. Yet risks remain if fundamentals, including lofty earnings expectations, fail to deliver.

On valuation, there’s some level of enthusiasm to be sure, particularly in areas like AI. However, at this juncture, this verve is probably more rational than irrational (paging Alan Greenspan and Bob Shiller!). As declared, the economy is sound, inflation is falling, the 10-year Treasury yield is off its peak, the Fed has finished raising rates, corporate earnings are ample, and technology is bliss. Given this backdrop, although the stock market is not exactly cheap, it is also not overly expensive when you consider where key factors like inflation, interest rates, and profits are expected to be in the coming years. Moreover, there is still approximately $6 trillion in cash “on the sidelines,” mainly in money market funds, a portion of which (not all, but some) will likely seek higher returns when the Fed eventually begins to ease.

Bottom line: while short-term estimates vary, our longer run outlook for US equities remains wildly bullish.

As always, there is perpetual motion in economics and financial markets, so it’s vital to make decisions based on the available information. We find great joy in this important vocation. Which I suppose leads us back to where we began, with Mr. Stein’s observation … but with a twist. What happens if something, like the work of a steadfast financial advisor, can go on forever? Thanks for your unrelenting trust.

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.


Quarterly Letter Excerpt: From John Bird’s Desk

Annual rate of homicides in the U.S.

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.