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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.

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Conference Call Recording – February 2024

Albion Financial Group – February 2024 Conference Call Video Recording

In our most recent conference call our panelists delved into the economic context of early 2024, touching upon various topics such as tax deadlines, interest rates, Artificial Intelligence, recession forecast, inflation and pricing trends, monetary policy, portfolio asset allocation, Secure 2.0 legislation, estate planning, and more!

Stream the audio of yesterday’s conference call at this link.