The S&P 500 index rose for the second straight week, despite steep intraday selloffs on both Thursday and Friday. Interest rates fell sharply to start the week, with the 10-Year Treasury dropping from the previous Friday’s high of 4.9% to just 4.5%. However, Thursday morning’s hotter than expected inflation report marked the trough, and rates ended the week above 4.6%. Commodities were the big winners, as Gold prices surged 5.5% and oil jumped 5.9%.
One year ago, CPI inflation was at 8.2% per year, just off its highs. At the same time, though, inflation excluding the cost of housing, was dropping below 2% on a 3-month annualized basis. Housing costs matter, of course, but the government’s method for measuring housing costs notoriously lags the real-world experience. So when this pared-back measure of inflation reached the Federal Reserve’s target, equity markets responded by putting in their bear market lows. Today, the ex-housing measure has fallen perfectly to the Fed’s target – it’s at 1.98% over the past year. The shorter-term measure, however, is showing signs of reacceleration – it’s back up to 4.5%
Energy prices are to blame for the reversal. The cost of energy has jumped at an annualized rate of more than 30% over the past quarter.
ICYMI: Last week’s insights
Earnings Expectations and Valuation
Last year’s bear market decline was not driven by a deterioration in corporate earnings. Though stock prices dropped well over 20% from their peak to trough, expected future earnings remained stubbornly high. That divergence pushed the S&P 500 forward price-to-earnings ratio from more than 20x (a level previously seen only during the late-1990s) to 15x (a level in-line with historical averages).
The first half of 2023 was the opposite experience: stock prices rose, but earnings did not. Profits have now declined for three consecutive quarters. The market correction over the past few months has served to dampen valuations a bit, but at nearly 19x next year’s earnings, equities are still far from cheap when compared to historical norms.
Here’s the economic calendar for the week ahead