Tag: dji

Weekly Recap

It was a mixed bag for financial markets last week after fresh US inflation data for January came in somewhat higher than expected. Core CPI rose very slightly on a m/m basis, the second such sequential increase, while the m/m change in Core PPI rose for the 4th consecutive time. See the Chart of the Week for a time series.

The moderate uptick in real time inflation data coupled with the extremely strong January NFP report had market participants recalibrating their Fed expectations. After the February 1st rate hike of 25bp, futures markets suggested that only one more such hike would like occur at the March meeting, after which the Fed was expected to pause. Fast forward just two weeks, and futures now suggest that three more 25bp hikes are likely, one in each of March, May, and June. As a result of the shift in expectations for the Fed, bond investors saw rising yields and lower prices for the second week in a row, particularly towards the front end of the curve.

Equities were mixed last week. The Nasdaq outperformed, a rare occurrence with rising rates. Meanwhile, falling oil prices pulled down the energy sector, keeping the Dow flat and pushing the S&P slightly into the red. International markets were mixed as well, with weakness in Chinese stocks pulling E/M benchmarks lower.

Other economic data released last week showed stabilization in housing starts and building permits, and perhaps some cautious optimism (or at least less pessimism) on the part of homebuilders. Unemployment claims remain low, most gauges of manufacturing activity remain weak, and strong retail sales from January suggest the US consumer remains resilient despite inflation.

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. Most or all of 2022’s P/E multiple compression was driven by rates, rather than an expansion of the equity risk premium.

Interest Rates

Rates rose across the curve in 2022 in response to a dramatic pivot in monetary policy. Fed Fund Futures are pricing in a total of four 25bp hikes in 2023, with a “terminal” Fed Funds policy rate slightly above 5% for this cycle.

Inflation

After reaching 40yr highs in spring of 2022, inflation moderated in the second half of the year. Headline inflation eased over the summer on falling energy prices, and core inflation followed suit in Q4. Goods inflation has fallen due to softening demand and excess inventory, while heavily lagged housing data is one factor keeping reported services inflation elevated, at least for now.

Weekly Recap:

Financial markets had a challenging week after the previous Friday’s blowout Nonfarm Payroll report (+517k) caused investors to recalibrate their expectations for addition rate hikes this year. Going into the report on the morning of February 3rd, futures markets were pricing in just one additional 25bp hike at the March meeting. Afterwards, investors immediately priced in another 25bp hike at the May meeting, as well as roughly 50/50 odds of one more over the summer.

Bond yields rose across the curve in response, making it a challenging week for fixed income. Credit spreads were largely stable, resulting in similar performance between Treasuries and US corporates.

Equity markets responded in predicable fashion. The prospect of additional rate hikes in combination with somewhat lackluster Q4 earnings (in the aggregate, at least) sent stock prices lower over the course of last week, with more rate-sensitive growth sectors feeling the greatest selling pressure.

In the aftermath of the previous Friday’s NFP report, incoming economic data was fairly sparse last week. Initial jobless claims remained below 200k for the 4th straight week. Meanwhile, the University of Michigan’s Consumer Sentiment gauge rose to 66.4 in the preliminary February print (from 64.9 in January), with the gains driven by improvements in the current conditions component. Long term (5-10y) consumer inflation expectations remain well anchored at 2.9%.

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. Most or all of 2022’s P/E multiple compression was driven by rates, rather than an expansion of the equity risk premium.

Interest Rates

Rates rose across the curve in 2022 in response to a dramatic pivot in monetary policy. Fed Fund Futures are pricing in a total of three 25bp hikes in 2023, with a “terminal” Fed Funds policy rate of roughly 5% for this cycle.

Inflation

After reaching 40yr highs in spring of 2022, inflation has begun to moderate in recent months. Headline inflation eased over the summer on falling energy prices, and core inflation followed suit in Q4. Goods inflation has fallen due to softening demand and excess inventory, while heavily lagged housing data is one factor keeping reported services inflation elevated, at least for now.

Weekly Recap:

US equities had another strong week, particularly the Nasdaq which has benefitted from a sharp rebound in mega-cap technology stocks. After posting a 4.3% return last week, the Nasdaq is already up more than 11% so far in 2023. From a sector standpoint, 2023 returns have been clustered by style: growth sectors (tech, consumer discretionary, and comms) have outperformed, while traditional defensives (utilities, staples, and healthcare) have been used as a source of funds and have underperformed as investors have looked to add risk.

Bond markets were relatively quiet last week. The Treasury yield curve pivoted slightly, with short rates rising a few basis points while yields in the belly and long end fell by a similar amount. Credit spreads continued their slow grind tighter, pushing corporate bond prices higher. IG spreads have now tightened by roughly 40bp since peaking above 150bp in October of last year (see the Chart of the Week for a time series).

Economic data released last week reinforced existing trends: slowing manufacturing activity, moderating inflation, strong labor markets, and a resilient consumer.

• S&P’s US Mfg (46.8) and Svcs (46.6) PMIs remain in contraction territory
• Fed surveys (Philly, KC, Richmond, and Chicago) also remain in contraction
• Headline (+0.1% m/m) and core (+0.3% m/m) PCE deflators were modest
• Initial jobless claims fell to 186k, the lowest level since April of 2022
• U of M consumer sentiment (64.9) was revised slightly higher for January
• U of M inflation expectations were revised lower (1y = 3.9%; 5-10y = 2.9%)

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 slightly 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. Most or all of 2022’s P/E multiple compression was driven by rates, rather than an expansion of the equity risk premium.

Interest Rates

Rates rose across the curve in 2022 in response to a dramatic pivot in monetary policy. Fed Fund Futures are pricing in two additional 25bp hikes in 2023, with a “terminal” Fed Funds rate slightly below 5% for this cycle.

Inflation

After reaching 40yr highs in spring of 2022, inflation has begun to moderate in recent months. Headline inflation eased over the summer on falling energy prices, and core inflation followed suit in Q4. Goods inflation has fallen due to softening demand and excess inventory, while heavily lagged housing data is one factor keeping reported services inflation elevated, at least for now.

Weekly Recap:

Risk assets were mixed in the holiday-shortened week as a raft of softening economic data renewed concerns about a US recession:

• Retail Sales fell 1.1% in December, below consensus estimates
• US Industrial Production fell 0.7% in December, also below consensus
• US Capacity Utilization dropped to 78.8%, the lowest level in 12 months
• Empire Manufacturing (-32.9) fell to its lowest level since May of 2020
• US housing starts (-1.4%) and residential building permits (-1.6%) fell in December
• The NAHB Housing Market Index (35) remains deeply in contraction territory

Amid these signs of a slowing economy, inflation pressures continue to ease despite an extremely strong labor market. Producer Price Inflation (PPI) was -0.5% m/m in December and fell to +6.2% y/y, while Core PPI (ex food & energy) was just +0.1% m/m and dropped to +5.5% y/y. Meanwhile, initial jobless claims (a leading labor market indicator) fell to 190k, the first sub-200k print since September.

Bonds were mostly better bid on the soft economic data, with Treasury yields falling in the front end and belly, while IG credit spreads were stable. High yield spreads widened on the uptick in risk aversion.

Stocks were mixed: large cap tech continued its early-2023 run of outperformance thanks to falling discount rates, while cyclicals (ex energy) and small caps were mostly lower. International stocks outperformed the US yet again, continuing another early-2023 trend. Chinese equities posted their 4th straight week of gains even as a Covid wave has infected 80% of the population by some reports, leaving the MSCI China Index up 13.85% YTD.

Albion’s “Four Pillars”:

Economy & Earnings

US GDP rebounded to +2.6% in Q3 after falling in 1H22, and corporate operating margins remain solid at ~12% on the S&P 500. 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 17x is slightly 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. Most or all of 2022’s P/E multiple compression was driven by rates, rather than an expansion of the equity risk premium.

Interest Rates

Rates rose across the curve in 2022 in response to a dramatic pivot in monetary policy. Fed Fund Futures are pricing in two additional 25bp hikes in 2023, with a “terminal” Fed Funds rate slightly below 5% for this cycle.

Inflation

After reaching 40yr highs in spring of 2022, inflation has begun to moderate in recent months. Headline inflation eased over the summer on falling energy prices, and core inflation followed suit in Q4. Goods inflation has fallen due to softening demand and excess inventory, while heavily lagged housing data is one factor keeping reported services inflation elevated, at least for now

Weekly Recap

Steadily moderating inflation data helped push rates lower across the curve last week, which in turn drove P/E multiple expansion in stocks. CPI data for December was in line with consensus expectations across the board:

• Headline CPI declined 0.1% sequentially and fell to 6.5% y/y
• Core (ex food & energy) CPI was +0.3% m/m and fell to 5.7% y/y

Rates moved lower as the curve became slightly more inverted, pushing Treasury and other bond prices higher. After an extremely challenging 2022, fixed income is off to a strong start in 2023, with yields remaining attractive even as solid price gains have been realized in the first two weeks of the year.

Equities followed suit as falling risk-free rates enabled P/E multiple expansion. Longer-duration growth stocks were the biggest beneficiaries, driving significant outperformance by the Nasdaq. Defensive sectors lagged as utilities, staples, and healthcare stocks were used as a source of funds for portfolio re-risking.

Other economic news was mixed last week. The NFIB’s Small Business Optimism Index fell to 89.8, very close to the 9-year lows reached last summer. Labor markets continue to show signs of renewed strength as initial jobless claims fell to 205k, the lowest print since September. And finally, the University of Michigan’s Consumer Sentiment gauge rose for the second straight month in preliminary January data, with improvements in both the current conditions and expectations components. Near-term (1y) inflation expectations fell 40bp to +4.0%, while longer-term (5-10y) inflation expectations remain solidly anchored at +3.0%.

Albion’s “Four Pillars”

Economy & Earnings

US GDP rebounded to +2.6% in Q3 after falling in 1H22, and corporate operating margins remain solid at ~12% on the S&P 500. 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 17x is slightly 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. Most or all of 2022’s P/E multiple compression was driven by rates, rather than an expansion of the equity risk premium.

Interest Rates

Rates rose across the curve in 2022 in response to a dramatic pivot in monetary policy. Fed Fund Futures are pricing in two additional 25bp hikes in 2023, with a “terminal” Fed Funds rate slightly below 5% for this cycle.

Inflation

After reaching 40yr highs in spring of 2022, inflation has begun to moderate in recent months. Headline inflation eased over the summer on falling energy prices, and core inflation followed suit in Q4. Goods inflation has fallen due to softening demand and excess inventory, while heavily lagged housing data is one factor keeping reported services inflation elevated, at least for now.

2022 Year-End Recap

Inflation:

Post-pandemic inflation was the story for the global economy in
2022, as a combination of snarled supply chains and labor shortages were
exacerbated by Russia’s invasion of Ukraine, which sent energy prices
skyrocketing. Inflation reached a 40-year high in the US in the late spring,
but moderated somewhat in the second half thanks to falling energy prices,
fewer supply problems, and a slowly-but-steadily normalizing labor market.

Monetary Policy:

If inflation was the fuel for the 2022 bear market, monetary policy was the match that lit the flame. At the start of the year, the Fed still had overnight interest rates pinned at zero, and Fed Fund Futures markets were pricing in just three 25bp rate hikes in 2022. Fast forward 12 months, and the Fed has enacted the equivalent of seventeen 25bp hikes, including four consecutive 75bp increases, pushing its policy rate floor to 4.25%. Central banks around the world have followed suit in the fight against global inflation, including the Bank of England, the ECB, and even the Bank of Japan. Looking ahead to 2023, markets are expecting a much more balanced monetary posture, with two small rate hikes expected from the Fed early in the year, and the potential for cuts on the horizon towards the end.

Economy:

The US economy normalized somewhat in 2022, with growth
decelerating after a torrid +5.9% pace in 2021. GDP growth was mildly
negative in the first two quarters this year, but the US has avoided recession thus far, thanks largely to a resilient consumer. Over the course of the year, most gauges of manufacturing activity weakened, and housing decelerated sharply thanks to soaring mortgage rates. Looking forward, Albion’s expectation is that the Fed’s monetary tightening will ultimately cause the economy to enter recession at some point in 2023.

Bond Market:

Driven by the Fed’s sharp pivot to inflation-fighting, US fixed income endured one of its worst years in history. Treasury yields rose by 200- 350bp as the curve became almost completely inverted, and IG credit spreads widened by more than 30bp. No sector of the bond market was spared the decline in prices, although the restoration of yield to decade-plus highs helps to brighten the outlook for fixed income investors going forward.

Stock Market:

After reaching an all-time high on the first trading day of
2022, the S&P 500 spent most of the year in a bear market. Equity returns
were primarily driven by duration exposure, with long-dated growth sectors (especially technology) hit the hardest while dividend-rich sectors fared better. Energy was an upside outlier all year thanks to the dramatic rise in oil and gas prices following Russia’s invasion of Ukraine. International stocks finished lower as well, with China giving investors a particularly turbulent ride in 2022 thanks to Beijing’s ever-evolving Covid and economic policies.

Albion’s “Four Pillars”

Economy & Earnings

US GDP rebounded to +2.6% in Q3 after falling
1H22, and corporate operating margins remain solid at ~12% on the S&P 500 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 17x is slightly 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. Most or all of this year’s P/E multiple compression has been driven by rates, rather than an expansion of the equity risk premium.

Interest Rates

Rates have risen across the curve in 2022 in response to a shift in monetary policy. Fed Fund Futures are pricing in two additional 25bp hikes in 2023, with a “terminal” Fed Funds rate slightly below 5% for this cycle.

Inflation

After reaching 40yr highs in spring of 2022, inflation has begun to moderate in recent months. Headline inflation eased over the summer on falling energy prices, and core inflation has followed suit in Q4. Goods inflation has fallen due to softening demand and excess inventory, while heavily lagged housing data is helping to keep services inflation elevated.

Weekly Recap:

Rates took center stage once again last week, rising around the world after the Bank of Japan surprised markets by increasing the allowable trading range on 10-year Japanese government bonds by 25bp. Investors interpreted the move as a first step towards what could become a gradual normalization of Japanese monetary policy after many years of ultra accommodative rates and yield curve control.

In the US, the Treasury market responded instantly (even at 10:00 pm Eastern time!) as yields rose by 10-12bp across the curve due to shifting global relative value. By the end of the week, belly and long end rates in the US were up by roughly 25-30bp depending on the curve point. Meanwhile, Fed Funds Futures markets priced in a 30% chance of a 3rd rate hike next year (at least 2 were already expected).

The coordinated move higher in rates had a predictable effect on US equities, as sectors and benchmarks traded in line with their duration exposure. Growth stocks significantly underperformed, pushing the Nasdaq lower, while shorter duration dividend stocks (particularly in the energy sector) drove gains in the Dow. The S&P fell in the middle, as it often does in rate-driven markets, posting a small loss on the week.

Economic data was abundant, and mixed. On the positive side, the Conference Board’s Consumer Confidence gauge (108.3) staged a sharp rebound to reach an 8-month high, and initial jobless claims (216k) continued their recent run of strength. However, housing metrics remain weak, including the NAHB Housing Market Index which fell to 31 (barely above pandemic lows), existing home sales (-7.7% m/m), and new residential building permits (-11.2% m/m). In addition, the Conference Board’s Leading Economic Index (LEI) declined for the 9th consecutive month, reaching -4.5% on a y/y basis. Historically such levels have been associated with the imminent onset of recession (Chart of the Week).

Albion’s “Four Pillars”

Economy & Earnings

US GDP rebounded to +2.6% in Q3 after falling in 1H22, and corporate operating margins remain solid at ~12% on the S&P 500. 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 17x is slightly 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. Most or all of this year’s P/E multiple compression has been driven by rates, rather than an expansion of the equity risk premium.

Interest Rates

Rates have risen across the curve in 2022 in response to a shift in monetary policy. Fed Fund Futures are pricing in two additional 25bp hikes in 2023, with a “terminal” Fed Funds rate slightly below 5% for this cycle.

Inflation

After reaching 40yr highs in spring of 2022, inflation has begun to moderate in recent months. Headline inflation eased over the summer on falling energy prices, and core inflation has followed suit in Q4. Goods inflation has fallen due to softening demand and excess inventory, while heavily lagged housing data is helping to keep services inflation elevated.

Weekly Recap

Last week’s main event was the December FOMC meeting. As expected, the Fed raised overnight interest rates by 50bp, bringing the final tally for 2022 to 425bp of increases since “lift-off” in March. But despite better-than-expected CPI data that was released earlier in the week, Jerome Powell’s inflation-fighting rhetoric was as hawkish as ever, dampening equity investors’ hopes of a more dovish Fed in 2023.

The Fed’s impact on equity trading was very obvious last week. From Monday’s open through 2:00 pm on Wednesday (the time of the Fed’s rate decision and press release), the S&P 500 rose nearly 3% thanks to the aforementioned moderation in the inflation trend. But from the conclusion of the FOMC meeting through Friday’s close, the index fell nearly 5%, to finish down 2% overall on the week. Most other domestic and international equity benchmarks experienced similar declines.

Meanwhile, the bond market’s response suggested that investors are becoming less concerned about inflation, and more concerned about a Fed-induced recession. Fed Fund Futures markets continue to undershoot the Fed’s own interest rate projections (see the updated Dot Plot below), and Treasury yields fell across the curve following the FOMC meeting, pushing bond prices higher.

Apart from the Fed and inflation, most of last week’s incoming data suggested a slowing economy. Retail sales fell 0.6% sequentially in November, while Industrial Production and Capacity Utilization both fell by 20bp. Meanwhile, the Empire Manufacturing (-11.2) and Philly Fed (-13.8) surveys both sunk deeper into contraction territory in the December prints, as did S&P’s US Manufacturing (46.2), Services (44.4), and Composite (44.6) PMIs.

Albion’s “Four Pillars”

Economy & Earnings

US GDP rebounded to +2.6% in Q3 after falling in 1H22, and corporate operating margins remain solid at ~12% on the S&P 500. 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 17x is slightly 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. Most or all of this year’s P/E multiple compression has been driven by rates, rather than an expansion of the equity risk premium.

Interest Rates

Rates have risen across the curve in 2022 in response to a shift in monetary policy. Fed Fund Futures are pricing in two additional 25bp hikes in 2023, with a “terminal” Fed Funds rate slightly below 5% for this cycle.

Inflation

After reaching 40yr highs in spring of 2022, inflation has begun to moderate in recent months. Headline inflation eased over the summer on falling energy prices, and core inflation has followed suit in Q4. Goods inflation has fallen due to softening demand and excess inventory, while heavily lagged housing data is helping to keep services inflation elevated.

Weekly Recap

Risk assets struggled last week as concerns about global economic growth intensified. Oil fell nearly $9/barrel to its lowest level since December of last year. Meanwhile, a higher than expected Producer Price Inflation (PPI) print for November pushed short rates higher. While PPI remains well off its highs on a y/y basis (see the Chart of the Week), the sequential reacceleration in core (ex food & energy) PPI to +0.4% m/m was noteworthy, particularly in the context of recent comments by various FOMC members about the inflation fight being far from over.

Rising short-term yields deepened the Treasury curve inversion and sent bond prices lower for the first time in more than month. Nevertheless, futures markets remain firmly coalesced around a +50bp rate hike this week, with the February 1st meeting considered to be “in play” for another +50bp hike, or a further deceleration to only +25bp. Credit spreads remained stable on the week, pushing small price declines through to US corporate bonds.

Domestic equity markets endured a week of rough performance, with most benchmarks down somewhere in the 3% to 5% range. Small caps underperformed. International stocks were better, particular E/M which was boosted by another week of strong performance from Chinese equities. Since bottoming out at the end of October, the MSCI China index is up nearly 40% in just six weeks on growing optimism that Beijing’s Zero Covid policy is being replaced by less draconian containment strategies.

Albion’s “Four Pillars

Economy & Earnings

US GDP rebounded to +2.6% in Q3 after falling in 1H22, and corporate operating margins remain solid at ~12% on the S&P 500. 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 17x is slightly 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. Most or all of this year’s P/E multiple compression has been driven by rates, rather than an expansion of the equity risk premium.

Interest Rates

Rates have risen across the curve in 2022 in response to a shift in monetary policy. Fed Fund Futures are pricing +50bp in December and 2 additional 25bp hikes in 2023, with a “terminal” Fed Funds rate slightly below 5% for this cycle.

Inflation

After reaching 40yr highs in spring of 2022, inflation has begun to moderate in recent months. Headline inflation eased over the summer on falling energy prices, and core inflation has followed suit in Q4. Goods inflation has fallen due to softening demand and excess inventory, while heavily lagged housing data is helping to keep services inflation elevated.

Weekly Recap

Stocks and bonds rallied in unison last week, thanks largely to comments from Fed Chair Jerome Powell on Wednesday afternoon. Speaking at the Brookings Institute, Powell confirmed that the Fed might slow the pace of rate hikes as soon as the December FOMC meeting. Investors interpreted that to mean that the days of 75bp hikes were over. Futures markets quickly crystalized around a 50bp hike in December, and lowered the expected number of 25bp rate hikes in 1Q23 from 3 to 2.

The impact on bond prices was significant, bringing welcome relief to battered investment grade bondholders. The Treasury yield curve experienced a parallel shift lower by 18-19bp over the course of the week, and credit spreads compressed slightly, extending the tightening trend that began in mid-October. Yields on IG corporates have fallen by roughly 100bp in that time.

Equities got a boost from Powell’s comments as well, particularly rate-sensitive growth stocks in the tech, consumer, and communications sectors. Dividend payers lagged the rally, particularly financials and energy as rates and oil prices dropped, respectively. Meanwhile, Chinese equities continued to move higher on hopes that public unrest would accelerate the removal of Beijing’s “Zero Covid” policy.

Economic news was abundant last week. Housing metrics (prices, sales) were weak, manufacturing gauges point to a contraction in activity, and consumer confidence waned a bit. On the flip side, despite rising unemployment claims and a reduction in open jobs, the monthly nonfarm payroll report came in above expectations at +263k (see the Chart of the Week), while unemployment held steady at 3.7%.

Albion’s “Four Pillars”

Economy & Earnings

US GDP rebounded to +2.6% in Q3 after falling in 1H22, and corporate operating margins remain solid at ~12% on the S&P 500. 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 17.5x is slightly 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. Most or all of this year’s P/E multiple compression has been driven by rates, rather than an expansion of the equity risk premium.

Interest Rates

Rates have risen across the curve in 2022 in response to a shift in monetary policy. Fed Fund Futures are pricing +50bp in December and 2 additional 25bp hikes in 2023, with a “terminal” Fed Funds rate slightly below 5% for this cycle.

Inflation

After reaching 40yr highs in spring of 2022, inflation has begun to moderate in recent months. Headline inflation eased over the summer on falling energy prices, and core inflation has followed suit in Q4. Goods inflation has fallen due to softening demand and excess inventory, while heavily lagged housing data is helping to keep services inflation elevated.