Fresh inflation data for the month of August did little to change the narrative last week. Although a supply-driven spike in energy prices drove the headline numbers higher, the disinflationary trend in core inflation remains intact. This is true for both consumer (CPI) and producer (PPI) prices:
* Headline CPI was +0.6% m/m and +3.7% y/y
* Core (ex food and energy) CPI was +0.3% m/m and +4.3% y/y
* Headline PPI was +0.7% m/m and +1.6% y/y
* Core PPI was +0.2% m/m and +2.2% y/y
All of this data was very close to consensus expectations, and Fed Funds Futures markets were largely unmoved by it. Futures continue to imply a slightly less than 50/50 chance of one additional rate hike prior to year-end, most likely at the December meeting if it occurs at all, followed by a multi-meeting pause.
Rates markets were soft despite the incoming data, particularly in the belly and long end of the curve where yields rose 7-8bp. Investment grade credit spreads remained stable near long-run averages, passing the price declines from Treasuries through to high quality corporates.
Stocks were mixed against the relatively calm macro backdrop. Tech stocks finished lower on the week, in part due to somewhat disappointing results from Oracle (relative to very lofty expectations at least) that temporarily dented investor enthusiasm for A/I story names. Most other sectors finished close to flat or slightly higher on the week. International stocks outperformed, but continue to lag the US on a YTD basis.
Albion’s “Four Pillars”:
Economy & Earnings
The US economy showed resilience in the first half of 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 the second half of 2023, putting downside pressure on earnings.
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 (Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.
Rates rose dramatically in 2022 due to a sharp pivot in monetary policy, and have remained elevated in 2023 as progress on inflation has been slower than hoped. Futures markets now imply that the Fed Funds overnight interest rate will remain unchanged at 5.25-5.50% until at least March of next year.
After reaching 40yr highs in spring of 2022, inflation has moderated somewhat over the past 12 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.