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Quarterly Letter – Fourth Quarter 2024

INTRODUCTION

As we bid farewell to the first quarter of the 21stcentury, we stand at the crossroads of innovation and uncertainty, where the echoes of past challenges mingle with the whispers of future possibilities. In this letter, our CEO John Bird explores how perspectives of political events have shifted over time, challenging our understanding of economic decision-making. Our CIO Jason Ware remarks on the economics of 2024, setting the stage for an intriguing financial landscape in 2025.Then, Senior Wealth Advisor Anders Skagerberg, standing at the threshold of this new year with its opportunities and challenges, looks to turn your aspirations into achievable goals and navigate the evolving landscape of personal finance with confidence and clarity.

FROM JOHN BIRDโ€™S DESK

While inauguration day is still several weeks away itโ€™s clear President elect Trump is already having an impact on how we view policy and economics domestically and globally. Markets responded favorably to his propensity toward deregulation and lower taxes. Individual reactions to Trumpโ€™s statements vary wildly depending on preconceived notions of his policy and personal views of his character. This is normal. Yet for the better part of a century the field of economics treated human emotions as secondary. When and why did economics become a field viewing itself as distinct from politics specifically and the vagaries of the human condition writ large?

The study of political economy evolved in the sixteenth century as philosophers of the time worked to understand the interplay of government policy and household management. These early writers wanted to know how we as individuals made decisions and how
government policy choices impacted those decisions. Adam Smith is perhaps the best known visionary in this school of thought though there were several others influential at the time. An overriding thesis was the notion that allowing for individual incentives fostered greater creativity, effort, and wealth creation than dictates from on high.

Centuries later, toward the end of the eighteen hundreds physical sciences were expanding understanding of our natural world through the scientific method and increased use of mathematics. It was in this period that the term โ€œeconomicsโ€ began to supplant โ€œpolitical economyโ€ as the field worked to shift more toward mathematical modeling of economic decision making with less reliance on factoring in the human emotional element driving the course of our economic path.

In the twentieth century the study of economics was dominated by factors that could be quantified. Numbers ruled the roost. And this period gave us volumes of insights into the working of our economic system which continue to help guide policy and investment decisions today. Yet an awareness of the importance of human behavior in economics can scarcely be overstated. Many of us work to be logical in our decision-making. But when we pull the trigger, it is the emotion of the moment that compels us to act. As investors we ignore this reality at our peril.

The University of Michigan collects data on consumer sentiment based on political party and the insights are a striking example of how our worldview impacts our perceptions. The information highlights that when a democrat is elected to the oval office democratic consumer sentiment spikes upward while republican sentiment plummets. When a republican is elected the effect is inverted. These changes in sentiment are at best loosely correlated (and typically not correlated at all) to unemployment rates, income growth, interest rates or other quantifiable factors that impact aggregate financial well-being. Rather, itโ€™s us as humans acting โ€ฆ human. Turns out how we feel about something has a big impact.

When we look at how we respond to various events โ€“ like elections โ€“ itโ€™s clear that โ€œpolitical economyโ€ is a better way of understanding our environment and our behaviors than economics alone. Itโ€™s also essential to note that while we may understand the why of the financial markets a bit better that doesnโ€™t mean we should change our approach. We continue to invest in companies with competitive advantages that can be sustained for the foreseeable future. We continue to hold those companies regardless of the emotions of the moment. Sometimes in the face of emotional swings so common to our human condition our best course of action is to follow the advice of the white rabbit in Lewis Carrolโ€™s Alice in Wonderland: โ€œDonโ€™t just do something, stand there.โ€ As we enter 2025, we will keep the wise words of said rabbit in mind and keep a steady hand on the tiller of your investments. Thank you for your continued trust and confidence in the Albion team. We wish you a healthy and prosperous new year.

ECONOMY & MARKETS by Jason Ware

What a charmed time this has been for Wall Street! The economy and earnings are doing well. Inflation and interest rates are coming down. Shoppers are outshopping. The US dollar has rallied, and the incoming administration is assumed to be more business friendly. The stock market is in its happy place as evidenced by yet another +20% annual gain. As we close out the year, let us explore each.

The US economy is strong. The labor market is healthy, people are pending, we have a boom in technology capex(AI and Cloud), and there remains a sturdy pro-growth fiscal tailwind. Things look fine today (nothing in the data points to recession) and growth in the years ahead should be stronger than the decade pre-Covid โ€ฆ not by a lot, but better โ€ฆ on rising real incomes, sustained expansionary policies from the Beltway, strong spending and investment on infrastructure and technology, and enhanced productivity.

On prices, the 2021-23 inflation problem has been solved. Not in terms of price level, thatโ€™s not going back down (a good thing). But as it relates to price growth, weโ€™re now far better off. While the Fed’s 2% target remains elusive, we are close. Our view holds (for a few reasons) that we can expect inflation roughly in the mid-2s โ€ฆ that 2% will be this cycle’s floor not its ceiling (like in the 2010s) โ€ฆ and that’s just fine. Anything under 3% should be constructive for the economy and financial markets.

Meanwhile, the Fed is now in an easing cycle with a goal to arrive at โ€œneutral.โ€ For those with better things to do than study magic numbers in economics, the neutral rate is essentially inflation plus what economists call โ€œr-starโ€ (r*)โ€“ a real rate of interest that’s said to balance the economy. Neutral policy is neither expansionary nor contractionary. Presently, we consider this level to be perhaps 3.5-4.0% (note: for its part, the Fed currently thinks itโ€™s 3%). Meaning, if things go well, we can expect a couple more quarter-point cuts along this path. Now, it’s possible (probable?) this won’t go perfectly to plan without some hiccups, but it could. And if so, that’s conceptually the track forward.

Bond yields take their cues from this base rate math. If 3.5-4.0% represents neutral fed funds and a reasonable term premium for the 10-year Treasury is maybe 1.0% or so, then 4.5-5.0% would be structural equilibrium. On the investment grade corporate side, add about +0.75-1.0% in risk premium. Certainly, these things will move around based on factors like mood, geopolitics, prospects for growth, inflation, and government deficits, making real-time bond yields messier than this straight-forward theoretical exercise. Nevertheless, today is a pretty good time to lock in yields, where appropriate, for balanced accounts.

Over in equity land, unsurprisingly we remain long run bullish on US stocks. The American system endures as the most innovative, dynamic, nimble, and resourceful economy on the planet. The finest universities, brightest minds, and most cutting-edge companies all reside here, not to mention the deepest and most efficient capital markets around. Combined, this is what Buffett calls the โ€œAmerican tailwindโ€ โ€“ a force the now 94-year-old sage still believes will propel us onward in the years and decades to come. We agree. Accordingly, our belief is that stock prices will continue to do what theyโ€™ve always done: track the general direction of workforce demographics, economic growth, innovation, and business profits, all of which move up over time taking with them the long-term oriented investor.

Speaking of corporate profits, the single biggest item that informs stock prices, theyโ€™re at record highs. Itโ€™s likely that the S&P 500 logged ~$240 in earnings-per share (EPS) in 2024. If the economy holds up (our base case) we could see ~$275 in 2025 and perhaps ~$300 in 2026! For perspective, EPS troughed at ~$138 during Covid and was ~$162 the year before the pandemic. US companies are quite skilled at making money. More importantly, our portfolio companies continue to shine on this front. We still skew positive for our outlook on corporate earnings. Naturally though, there are some warts. Notable is valuation as stocks aren’t cheap. However we don’t deem them as expensive as those who cite “24x”, CAPE, or whatever. Moreover, it depends on where one chooses to look. Are there expensive parts of the market? Absolutely. More attractive expanses? Totally. At the index level, the S&P 500 currently has a price-to-earnings ratio (P/E) of just over 24x 2024 EPS and 21x that of 2025. Again, not cheap, but not crazy either. It’s been higher at times, and P/E is a terrible timing tool (its best use is to gage expected returns over longer periods, like a decade) so we can’t glean much from these figures as to where the market goes short run. Resultantly, we judge valuation as OK especially if earnings are expanding, inflation is benign, and we’re in an easing cycle with sensible and stable(ish) long rates. Too, post-election, we believe that earnings over the next year or two might come in higher than existing estimates on the notion that less regulation, lower taxes, and increased buybacks could fuel even loftier figures. Weโ€™ll see.

Underneath the index level, technology, AI, and the โ€˜Mag 7โ€™ do look richer relative to other areas, while most everything else is cheaper (S&P 500 is ~16x ex-tech). Spots like health care (and other โ€œdefensivesโ€), industrials, REITs, small caps, mid-caps, international, all sport lower valuations โ€“ both on a relative and absolute basis. The practical application of this being that portfolio construction and investment tilts matter, while diversification is still the only โ€œfree lunchโ€ when investing. If equities broaden out (in earnest) in 2025, itโ€™ll be important to have suitable exposures while preserving deliberate tilts toward quality businesses in tech and growing consumer names. Adding up the puts and takes, we think it unlikely the S&P 500 will be driven by multiple expansion in the years to come. Rather, earnings growth may contribute the lionโ€™s share of the return. But donโ€™t let that get you down beat. If earnings compound at, say, +6-8% (utterly doable) while dividends and buybacks add another couple percent, then the S&P 500 as purely an โ€œearnings growth and shareholder returns storyโ€ can be a good stock market indeed. Falling P/Es would be a head wind to this calculus, but for now thatโ€™s not our expectation.

As we look ahead to 2025 we are calling it โ€œA Year of Three-Twos.โ€ That is, a US economy firmly growing mid-2s; (core) US inflation settling into the mid-2s; and a Fed that maybe cuts 2 times. 222 โ€ฆ an โ€œangel numberโ€ (letโ€™s hope!). Of course, amid all these variables and moving parts weโ€™ll continue to do our job as your investment manager in navigating the landscape for our companies / investments. Thanks for your continued trust in us, and Happy New Year!

PLANNERS CORNER by Anders Skagerberg

As we step into 2025, the planning team remains committed to guiding you to a lifetime of good decisions. 

The start of a new year is a chance to reflect, refocus, and take meaningful steps toward your financial goals. Whether youโ€™re planning for a major milestone, fine-tuning your retirement plan, or simply looking to enhance your financial knowledge, weโ€™re here to support you every step of the way.

Looking back, 2024 was a big year – markets were up, we had a presidential election, and so much more. As we look forward to the new year, no one knows for certain what it will hold, but weโ€™re confident that with thoughtful planning and a focus on what truly matters, it can be a year of progress, opportunity, and positive change.

In this plannerโ€™s corner update, we will cover:

  1. How to Crush Your Financial Goals in 2025
    Practical tips and strategies to set meaningful goals, automate your success, and celebrate progress along the way.
  1. Key Updates for 2025
    A look at higher contribution limits, expanded gifting opportunities, Social Security adjustments, and new catch-up provisions for those nearing retirement. 
  1. What Weโ€™re Working on This Quarter
    An overview of our initiatives, from updating RMD calculations to integrating income and employer benefits changes into your financial plan.

Letโ€™s make 2025 a year of financial progress and success. Together, weโ€™ll navigate the opportunities and challenges ahead with confidence and clarity!

Next, How to Crush Your Financial Goals in 2025

As we kick off the new year, itโ€™s the perfect moment to take a step back and think about what matters most to youโ€”and how your finances can support that vision. 

Depending on your stage of life, your financial goals might be less about growing your wealth and more about maintaining it, simplifying your financial life, or finding ways to use your money to create lasting memories with those you love. 

Whatever your focus, the key is to make your goals clear and actionable.

Instead of aiming to โ€œsave moreโ€ or โ€œspend less,โ€ think about specifics. Maybe you want to fund a family trip, increase your charitable giving, or update your estate plan. Having a concrete goal gives you something to measure progress againstโ€”and makes it much easier to see the finish line.

Once youโ€™ve clarified your goals, itโ€™s time to focus on how to make them happen. One of the simplest ways to stay on track is to automate whenever possible. Automating your distributions, bill payments, or even charitable contributions ensures youโ€™re consistent without having to think about it too much. Plus, it gives you more time and energy to focus on what really mattersโ€”whether thatโ€™s planning your next adventure, enjoying time with family, or pursuing a hobby you love.

Of course, flexibility is just as important as structure. Life has a way of throwing curveballsโ€”unexpected expenses, changes in tax laws, or even an unexpected opportunity you want to pursue. Having some wiggle room in your financial plan can help you roll with the punches while staying on track. For some, that might mean keeping a healthy amount of cash on hand or simply revisiting their plan more regularly to make adjustments.

As you think about the year ahead, itโ€™s also worth reflecting on the bigger picture. How does your financial plan fit into the legacy youโ€™re building? Maybe itโ€™s about leaving something meaningful for your loved ones or supporting causes youโ€™re passionate about. Having a conversation with your family about your values, your estate plan, or even your charitable intentions can make all the difference in ensuring your vision is carried forward in the way you intend.

Finally, donโ€™t forget to pause and appreciate the progress youโ€™ve already made. Achieving your goalsโ€”big or smallโ€”is worth celebrating. 

Whether itโ€™s checking off a bucket-list experience, reaching a financial milestone, or simply enjoying the peace of mind that comes with knowing youโ€™re on track, these moments matter. They remind us that financial success isnโ€™t just about the numbers; itโ€™s about living the life you want and sharing it with the people you love.

Hereโ€™s to making 2025 a year full of progress, purpose, and the joy that comes from seeing your hard work pay off.

Next up, here are some key financial updates to be aware of for 2025.

Key Updates for 2025:
  • Higher Contribution Limits:

401(k)/Roth 401(k): Increased to $23,500, with a $7,500 catch-up for those aged 50+.

IRA/Roth IRA: Remains at $7,000 with an additional $1,000 catch-up if youโ€™re 50+.

HSA: Increased to $4,300 for individuals and $8,550 for families, with a $1,000 catch-up for those aged 55+.

Qualified Charitable Distributions (QCDs): Increased to $108,000 for those over age 70.5. This can be a great way to support the charities you love while receiving valuable tax savings.

  • Social Security Benefits COLA Increase:

Social Security benefits will receive a 2.5% Cost-of-living increase for 2025.

  • Expanded Gifting Opportunities:

The annual gift tax exclusion has increased to $19,000, (up from $18,000) offering more opportunities for tax-efficient wealth transfers. This means that you can give $19,000 tax-free each year to any person. For a couple, thatโ€™s a combined $38,000 per year they can give to a single person.

  • NEW โ€œExtraโ€ Catch-Up Contributions for those age 60, 61, 62, and 63:

Larger catch-up contribution limits are now in place for those aged 60-63, making it easier to save more if youโ€™re nearing retirement age. The limit is $11,250 instead of $7,500. This is a new change as of this year and is part of the Secure 2.0 Act passed in 2022.

  • Inherited IRA RMDs

If you inherited an IRA from someone other than your spouse after January 1, 2020, the SECURE Act introduced a 10-year rule requiring the account to be fully distributed by the end of the 10th year following the original owner’s death. For beneficiaries where the original account owner had already begun taking required minimum distributions (RMDs), the IRS requires annual RMDs in addition to the account being emptied by the end of the 10-year period.

However, due to clarifications and administrative challenges, the IRS waived the annual RMD requirement for 2020 through 2024. This means that even if you didnโ€™t take any distributions during these years, you did not face penalties. Starting in 2025, the annual RMD requirement will resume, and beneficiaries must take these distributions or potentially face penalties. The 10-year deadline for fully depleting the account remains unchanged.

If you are interested in learning more about any of these updates or need additional clarification, as always, we are here to support you. 

Next up, here are some of the things we are working on this quarter as well as a few action items for you.

What Weโ€™re Working on This Quarter

The start of the year is always a busy time, and weโ€™re focused on ensuring your financial plan is positioned for success. Hereโ€™s what the planning team is focused on:

  • Calculating Required Minimum Distributions (RMDs) for those who need them. For those who take monthly distributions to satisfy your RMD, we will be updating those amounts as well to reflect your new RMD for the year. 
  • Updating Payroll Information and Benefits: If youโ€™ve had changes in pay or recently made benefits elections during open enrollment, weโ€™re integrating those updates into your plan.
  • Annual Tax Packages: for those with taxable accounts (non-retirement accounts) you will be receiving your annual tax package that includes a summary of your portfolio income for 2024. Reminder: this is not a tax document, just a summary. Investment account tax documents will be available from custodians starting in mid-February.

Action Items for You:

  • If youโ€™ve received a raise, send us your updated pay stub so we can adjust your financial plan accordingly.
  • If your employer has an open enrollment period, share your benefits details with us to ensure your elections align with your goals.

Of course, this list is just a glimpse of what weโ€™re focusing on this quarter. As always, weโ€™re here to handle the details so you can stay focused on what matters most.

Ultimately, weโ€™re thrilled to kick off another year of partnering with you to make thoughtful, informed financial decisions. Hereโ€™s to a successful and prosperous 2025!


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. Additional information about Albion Financial Group is also available on the SECโ€™s website at www.adviserinfo.sec.gov under CRD number 105957. Albion Financial Group only transacts business in states where it is properly registered, notice filed or excluded or exempted from registration or notice filing requirements.

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2024 Market Recap

2024 Recap:

Economy:

Even as growth slowed in Europe and China, the US economy remained strong in 2024. Unemployment is low and wage gains are solid, supporting continued growth in consumer spending. Regional Fed surveys suggest that domestic manufacturing is still in a slump, but services PMIs (representing the bulk of the US economy) are solidly in expansion territory. Fiscal policy continues to be an economic tailwind thanks to a 2024 federal budget deficit equal to nearly 7% of GDP according to CBO projections.

Inflation:

The disinflation trend continued in 2024, albeit at a slower pace than in 2023 when inflation fell rapidly from its mid-2022 peak. With one month of data (December) still to come, CPI inflation had fallen 60-70 basis points in 2024 to +2.7% (y/y) headline and +3.3% core, while PCE inflation was down a more modest 20-30 basis points to +2.4% (y/y) headline and +2.8% core. Progress on inflation appeared to stall in late 2024 as shelter costs showed early signs of reacceleration.

Monetary Policy:

The FOMC cut overnight interest rates at each of the last three meetings in 2024, by a total of 100 basis points (1%). Futures markets imply that one or two 25bp more cuts are likely to occur sometime in 2025, after a near term pause. The Fed’s updated Summary of Economic Projections (SEP) released at the December meeting also suggest a slower pace of rate cuts (2 instead of 4) in 2025 and a higher terminal rate (~3%) than was previously forecast by committee members.

Election:

After Donald Trump earned a second term as US president and the GOP took control of both houses of Congress, US stocks rallied on the prospect of lower corporate taxes and less regulation. Meanwhile, rates moved higher on the potential inflationary impact of tariffs and tight border controls, as well as concerns regarding future US federal budget deficits.

Bond Market:

Treasury yields moved higher for a 4th consecutive year, and the yield curve mostly reestablished an upward slope after a 2+ year period of inversion. Credit spreads gradually got tighter, reaching an all time tight of 74 basis points on the Bloomberg US Corporate Agg index shortly after the election. Mortgage rates for 30-year fixed were in the 6% to 7+% range all year, constraining transaction activity in the housing market.

Stock Market:

US stocks soared for a 2nd straight year, led once again by large cap technology companies. Financials also delivered strong returns, thanks in part to a steepening yield curve. Most other parts of the equity market posted smaller but still positive total returns, including cyclicals, defensives, small caps, and internationals.

Albion’s “Four Pillars”:

Economy & Earnings

The US economy has been resilient despite the higher interest rate environment. S&P 500 earnings are on track for high single-digit y/y growth in 2024, with consensus calling for an acceleration to double-digit y/y growth in 2025.

Valuation

The S&P 500’s forward P/E of 22x is well above the long run average, so valuations are likely to be a headwind to future returns. More predictive metrics like CAPE, Tobin’s Q, and the Buffett Indicator (Eq Mkt Cap / GDP) suggest that compound annual returns from current levels over the coming decade are likely to be in the mid single digits.

Interest Rates

After the “hawkish cut” at the December 2024 FOMC meeting, a near term pause on further rate cuts is likely, and the curve has mostly resumed its normal upward slope. Belly and long end rates in the 4% to 5% range may represent the “new normal” given solid economic growth, lingering inflation pressures, and large US fiscal deficits.

Inflation

After the disinflationary trend resumed in the summer of 2024, more recent inflation data has shown some renewed signs of stickiness. Services inflation remains somewhat elevated, in part due to heavily lagged shelter costs.


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. Additional information about Albion Financial Group is also available on the SECโ€™s website at www.adviserinfo.sec.gov under CRD number 105957. Albion Financial Group only transacts business in states where it is properly registered, notice filed or excluded or exempted from registration or notice filing requirements.

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Monthly Market Recap – May 2024

May Recap:

Inflation:

Data released in May suggested that price pressures may have eased back just slightly in April. The m/m change in Core CPI fell 10 basis points sequentially to +0.3%, leaving the y/y figure at +3.4%. Similarly, the m/m change in the PCE Core Deflator also fell 10 basis points to +0.2%, with the y/y figure holding steady at +2.8%.

Monetary Policy:

May featured what might be termed “a meeting in two parts,” at least in terms of how financial markets reacted. At the conclusion of the FOMC meeting on May 1st, markets breathed a sigh of relief that the committee did not appear to be seriously contemplating rate hikes to combat sticky inflation. Rates fell across the curve in early May as a result, while Fed funds futures markets priced in a second rate cut prior to year-end. However, when the minutes from that meeting were released on May 22nd, investors were discouraged by the very clear reminder that many committee members lacked confidence that inflation was sufficiently under control to seriously contemplate rate cuts in the near term. Odds of a second rate cut in 2024 fell to roughly 50/50 by month end.

Economy:

Data released in May was mixed. The labor market remains strong but is gradually normalizing: new jobless claims remain low at ~220k per week, but job creation slowed (175k nonfarm payrolls added) and unemployment ticked higher by 10 basis points to 3.9%. Consumer confidence indicators were also mixed: the Conference Board’s index rebounded 4.5 points to 102.0, while the University of Michigan saw an 8 point decline to 69.1 with weakness in all components. Meanwhile, persistently high mortgage rates appear to have stalled any upward momentum in housing sector activity. Q1 GDP growth was revised lower by 30bp to +1.3% q/q annualized, but Q1 corporate earnings growth was robust at roughly +6% y/y for the S&P 500, well in excess of inflation.

Bond Market:

Treasury yields see-sawed, initially falling after what felt like a dovish FOMC meeting, only to reverse course and retrace most of that ground later in the month after the meeting minutes were released. Finally, yields fell again after the May 30th release of a downwardly revised Q1 GDP print, leaving bond prices higher on the month. Credit spreads remained steady throughout at levels that are very tight by historical standards.

Stock Market:

Stocks of nearly all stripes were higher in May, aided by the tailwinds of lower rates, solid corporate earnings, and renewed enthusiasm for A/I themed companies after yet another blowout earnings report from Nvidia. Falling oil prices pushed the energy sector slightly into the red, but all other sectors in the S&P 500 finished higher, led by technology stocks.

S&P 500 Total Return by Sector – May 2024

Albion’s “Four Pillars”:

Economy & Earnings

The US economy has been resilient despite the higher interest rate environment. Analysts are forecasting low double digit EPS growth in 2024; growth of that magnitude will depend on the economy avoiding recession.

Valuation

The S&P 500’s forward P/E of 20.3x 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 (Eq Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.

Interest Rates

Futures markets imply that the Fed will cut overnight interest rates once or possibly twice in 2024, most likely at some point in the 2nd half of the year. Rate cut expectations have been tempered recently due to sticky inflation prints.

Inflation

After falling rapidly in late 2022 and all of 2023, inflation has become sticky in the 3-4% range in early 2024. Services inflation remains somewhat elevated, in part due to heavily lagged shelter costs. Rising oil prices driven by armed conflicts in Ukraine and the middle east are also a risk to the inflation outlook.


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. Additional information about Albion Financial Group is also available on the SECโ€™s website at www.adviserinfo.sec.gov under CRD number 105957. Albion Financial Group only transacts business in states where it is properly registered, notice filed or excluded or exempted from registration or notice filing requirements.
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Market Recap – April 2024

April Recap:

Inflation: Data released in April continued to paint a picture of sticky inflation, with most metrics coming in slightly higher than consensus expectations. Core CPI is now +3.8% y/y based on the most recent print, while the Core PCE Deflator (the Fed’s preferred inflation gauge) stands at +2.8% y/y, both of which are above the Fed’s 2% inflation target. Moreover, real time inflation data suggests that core inflation (CPI and PCE) has been running at an annualized pace of around 4.5% so far in 2024.

Monetary Policy: There were no FOMC meetings in April (technically a meeting began on April 30, to conclude with a rate decision and press conference on May 1), and thus no changes to overnight interest rates. However, sticky inflation data caused market participants to further reassess the timing and magnitude of a rate cutting cycle. At the start of April, futures markets were pricing in 2 or 3 rate cuts in 2024, most likely beginning sometime over the summer. By month end, futures markets implied only one rate cut this year, occurring in either November or December.

Economy: Data released in April was mixed. The labor market remains strong: jobless claims are low (~200k initial claims per week), open jobs are plentiful (8.75 million per the most recent JOLTS report), job creation continues (303k nonfarm payrolls added), and unemployment is low (3.8%). There have been signs of a trough in US manufacturing, which has been in recession for nearly 2 years. However, consumer confidence has wanted in recent months thanks to sticky inflation, and higher mortgage rates appear to have stalled the upward momentum in housing sector activity. Q1 corporate earnings growth has been modest so far at +3.5% y/y, roughly in line with inflation meaning that real (inflation-adjusted) growth is close to flat.

Bond Market: Treasury yields moved higher over the course of April as market participants further recalibrated their expectations regarding the so-called “Fed pivot”, resulting in lower bond prices across the board. Credit spreads remain tight by historical standards, pricing in very little default risk. Mortgage spreads tightened a bit further in April, driving a smaller increase in mortgage rates (+38bp on average for 30y fixed) compared to the move in 10y Treasury yields (+48bp).

Stock Market: After posting significant gains in Q1, most domestic and international stocks struggled in April. China was a notable exception, with the MSCI China Index posting a 6.4% gain on the month, pushing E/M benchmarks into positive territory. In the US, all sectors except Utilities finished in the red, with rate-sensitive sectors like Real Estate and Technology facing the most selling pressure.

S&P 500 Total Return by Sector – April 2024

Albion’s “Four Pillars”:

Economy & Earnings

The US economy has been resilient despite the higher interest rate environment. Analysts are forecasting low double digit EPS growth in 2024; growth of that magnitude will depend on the economy avoiding recession.

Valuation

The S&P 500’s forward P/E of 20x 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 (Eq Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.

Interest Rates

Futures markets imply that the Fed will cut overnight interest rates once or possibly twice in 2024, most likely at some point in the 2nd half of the year. Rate cut expectations have been tempered recently due to sticky inflation prints.

Inflation

After falling rapidly in late 2022 and all of 2023, inflation has become sticky in the 3-4% range in early 2024. Services inflation remains somewhat elevated, in part due to heavily lagged shelter costs. Rising oil prices driven by armed conflicts in Ukraine and the middle east are also a risk to the inflation outlook.

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Monthly Market Recap – January 2024

January 2024 Recap:

Inflation

Data released in January showed that as 2023 drew to a close, inflation was generally tame, but not quite tame enough for the Fed to declare victory. The Core PCE Deflator (the Fed’s preferred inflation metric) stood at +2.9% y/y as of the end of December, the first sub-3% print since March of 2021. Meanwhile, Core CPI printed at +3.9% y/y, also the lowest since the first half of 2021. While these figures are directionally encouraging, the pace of disinflation has slowed in recent months, and both metrics remain solidly above the Fed’s long term 2% target.

Monetary Policy

The main event for market participants in January was the FOMC meeting that concluded on Wednesday the 31st. While no one expected a change in overnight interest rates out of that meeting, everyone was interested in getting an answer to the question of “will they or won’t they” begin cutting rates at the March meeting. The answer, delivered as clearly as can be given the constraints of Fed-speak, is no. Jerome Powell made it very clear that the committee does not anticipate that economic conditions will justify the start of a rate cutting cycle in March.

Economy

Outside of the manufacturing sector, which mostly remains in contraction, economic data released in January was solid. Consumer confidence continues to climb, thanks in part to falling inflation that everyone can see at the gas pump. Lower mortgage rates stimulated activity in the housing sector. And the labor market remains strong: jobless claims are low (~200k initial claims per week), open jobs are plentiful (9 million per the most recent JOLTS report), and job creation continues to chug along (216k nonfarm payrolls added in the most recent monthly BLS job report).

Bond Market

The yield curve steepened in January, with 2y yields falling slightly while yields in the belly and (especially) the long end rising a bit. Longer term yields continue to be challenged by the outlook for US budget deficits, making them somewhat more attuned to the election cycle (and especially growing populist impulses across the political spectrum) that will unfold over the course of 2024. Most bond prices finished the month lower, although a contraction in credit spreads (to levels that are nearing historic tights) helped to cushion the downside in corporate bonds.

Stock Market

US large caps enjoyed a solid first month of 2024, but as was the case last year the gains were concentrated in a comparatively small number of individual stocks. Cyclicals and defensives were much more of a mixed bag, resulting in underperformance of small and midcap benchmarks that have greater exposure to such industries. International markets were mixed as well, with emerging market indices especially weak due to sharp underperformance in Chinese equities.

January 2024 S&P 500 Total Return by Sector

Albion’s “Four Pillars”:

Economy & Earnings

The US economy was resilient last year, and Wall Street analysts expect full-year 2023 corporate earnings to be roughly flat y/y versus 2022. Analysts are forecasting approximately 10% EPS growth in 2024; growth of that magnitude will depend on the economy avoiding recession.

Valuation

The S&P 500’s forward P/E of 20x 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 (Eq Mkt Cap / GDP) suggest that compound annual returns over the next decade are likely to be in the mid single digits.

Interest Rates

Futures markets imply that the Fed will cut overnight interest rates several times in 2024, most like beginning mid-year. The belly and long end of the curve have already priced in a rate cutting cycle, with yields falling more than 100bp in the past few months.

Inflation

After reaching 40yr highs in mid-2022, inflation has moderated significantly over the past 18 months. Goods inflation has fallen due to softening demand and supply chain normalization, while services inflation remains somewhat elevated, in part due to heavily lagged shelter costs.

Albion’s Dashboard of Key Leading Economic Indicators as of 01/31/24
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2022 Market Recap

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.

2022 S&P 500 Total Return by Sector

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.

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Year-End 2021 Market Recap

SARS-CoV-2: The world experienced a number of twists and turns in the pandemic during the course of 2021. Vaccine rollouts during the first half of the year drove case counts lower in much of the developed world. The summer and early fall were dominated by the delta variant, which proved especially deadly for the unvaccinated. Omicron emerged in late November and quickly became dominant worldwide thanks to its ability to evade the initial protection from vaccines. Thankfully, evidence soon emerged that existing vaccines (and especially boosters) still provide significant protection against severe disease and death, and also that omicron is more likely to cause mild covid even in the absence of any protection from vaccines or previous infection.

Economy: The US economy grew rapidly in the first half of the year, but the pace of growth slowed in Q3 as the delta variant snarled supply chains worldwide. At year-end, consensus estimates for 2021 US GDP growth stand at +5.6%, which would be the highest since 1984. Housing and labor markets remain strong, jobs are plentiful (even if workers are not), household and corporate balance sheets are flush with cash, and demand for most goods and services is robust. At the same time, supply chain  bottlenecks and persistent labor shortages are causing inflation to run hot, at levels not seen in the US in more than 30 years.

Bond market: Bonds had a challenging 2021 as yields began to normalize from ultra-low levels coming into the year. But despite much hand-wringing about inflation, 10y and 30y Treasury yields actually peaked in March and the curve flattened as the year progressed. By year-end, investors were pricing in three rate hikes in 2022 as the Fed rapidly winds down its asset purchase programs. Meanwhile, credit spreads compressed as pandemic-driven default risk abated, cushioning price declines for investment grade corporate bond holders and generating strong returns in riskier high yield bonds.

Stock market: US stocks capped an excellent year with a strong December finish. Outperforming sectors in 2021 included energy (+54.4%), real estate (+46.1%), financials (+34.9%), and tech (+34.5%).  International stocks lagged, particularly emerging markets which collectively finished slightly lower on the year. Much of the drag in E/M came from China, which experienced multiple waves of regulatory scrutiny that caused investors to dial back their growth assumptions for many Chinese companies.