Weekly Market Recap

Last week’s biggest headline was consumer price inflation (CPI) which registered +5.0% y/y in May, the first “five-handle” US inflation print in nearly 13 years. Under the covers, however, the report was less alarming. Core CPI, which strips out volatile food and energy prices, was just +3.8% y/y.

Moreover, more than half of the total came from just six components associated with the release of pent-up demand: food away from home, lodging, airfares, rental cars, used cars, and vehicle insurance.

Markets paid attention to these details, and as a result, inflation-sensitive asset classes rallied last week. Equities were led by technology stocks, many of which have long-dated cash flows that are especially sensitive to discount rate assumptions. The return of tech leadership in equities dates to mid-May, shortly after the previous month’s CPI report which showed similarly transitory drivers underneath an upside headline surprise.

Bond markets also rallied, as 10y Treasury yields fell 10 basis points to 1.45%, their lowest level since early March when rates were still rising quickly. Credit spreads were stable, pushing corporate and muni bonds prices higher (and yields lower) in sync with Treasuries. Mortgage rates also fell last week.

Most commodities traded in a narrow range as inflation fears eased. That said, oil ticked higher by approximately $1/barrel, pushing WTI above $70 for the first time since the outset of the pandemic.


Weekly Market Recap

Weekly Recap: Equity markets rode a roller coaster fueled by inflation fears last week, with most stocks finishing lower. Headline inflation (as measured by CPI) rose above 4% for the first time since 2008, causing a short-lived spike in interest rates as well as widespread selling in equities as discount rates were
recalibrated. The fear of persistently higher inflation began to subside a bit
on Friday, allowing rates to fall and equities to recoup some of their losses.

Large cap tech stocks were hit the hardest, dragging down sector
performance for communications (-2.0%), information technology (-2.2%), and consumer discretionary (-3.7%). Meanwhile, cyclicals as well as traditional defensive sectors were mixed, with only consumer staples
(+0.4%), financials (+0.3%), and basic materials (+0.1%) finishing higher on the week.

Interest rates finished the week modestly higher, with benchmark 10y
Treasury yields rising 5bp while 30y yields were up 6bp. Credit spreads were mostly stable, resulting in small price declines across all sectors of the bond market on the back of the rise in Treasury yields.

Oil prices rose, with WTI closing back above the $65/barrel threshold.
Meanwhile, the national average price of gasoline rose above $3 per gallon
for the first time since late 2014. See the Chart of the Week for a time series.

Albion’s “Four Pillars”: Economy & Earnings – GDP growth was +6.4% annualized in Q1 2021, and is forecast to accelerate to +8.1% in Q2. Meanwhile, EPS for the S&P 500 turned positive y/y in Q4 2020 and will rise significantly y/y in Q1 2021 as the economy laps the onset of the pandemic.

Equity Valuation – the S&P 500’s forward P/E of 22x is above the historical average, and long-term valuation metrics like CAPE (cyclically adjusted P/E ratio) suggest that compound annual returns over the coming decade are likely to be in the single digits. That said, lower equity returns may be justified in the context of ultra-low yields on alternatives like bonds and cash.

Interest Rates – Rates remain low by historical standards despite recent
volatility, supporting equity valuations and lowering borrowing costs.

Inflation – After staving off deflation early in the pandemic, the Fed has
communicated tolerance for short periods of above-target inflation. A
cyclical bump in inflation may occur in 2021 as pent-up demand is released, testing the Fed’s resolve, but we do not expect higher inflation to persist.