February 5-9, 2024

Tactical Signal 9

With the S&P 500 achieving a commendable year-to-date gain of 4.06%, propelled by robust earnings guidance and positive job reports that have alleviated recession concerns,  our indicators and models persist in maintaining a fully favorable position (100%).

Investors heading into last Wednesday's FOMC meeting had expected Federal Reserve Chairman Powell's speech to declare the Fed's plans to lower interest rates in the coming quarter. On the contrary, the Fed maintained its restrictive stance and kept the target range for the federal funds rate at 5-1/4 to 5-1/2 percent. The overall narrative of the FOMC is that it's too early and premature to lower rates, resulting in the S&P 500 reacting negatively by dropping 1.55% that day. Nonetheless, the S&P 500 and Nasdaq Composite surged +1.41% and 1.13%, respectively, for the week, offsetting those losses on Friday's strong jobs and earnings reports.

Friday's jobs report includes an increase of +353k nonfarm payroll jobs last month, and the unemployment rate of 3.7% exceeded investor expectations regarding the strength of the US economy. Mega Seven companies like Meta surged by +20.51% on record quarterly revenue of $40 billion, its first-ever quarterly dividend payment, and a $50 billion stock buyback program, bringing its market cap to $1 trillion. Amazon surged by +7.98% on fundamentally strong above-consensus quarterly revenue of $170 billion. Not to be overlooked, NVIDIA also gained +8.40% on the Meta coattails, while Google fell by -6.44% on core advertising revenue that disappointed analysts, even though overall revenue and earnings exceeded expectations.

The bond market witnessed significant fluctuations last week, marked by the initial narrowing of the 20-year yield from 4.49% to 4.21%, only to widen again to 4.33% following Friday's impactful jobs report. Given the Federal Reserve's prevailing restrictive stance, volatility in the bond market is expected to persist during this period.

With the Fed's stance solidified until the next meeting in March, the upcoming week will focus on earnings reports from key industry leaders such as McDonald's, Caterpillar, Eli Lilly, Walt Disney, ConocoPhillips, and Pepsico.

"We believe that our policy rate is likely at its peak for this tightening cycle and that, if the economy evolves broadly as expected, it will likely be appropriate to begin dialing back policy restraint at some point this year. But the economy has surprised forecasters in many ways since the pandemic, and ongoing progress toward our 2 percent inflation objective is not assured. The economic outlook is uncertain, and we remain highly attentive to inflation risks. We are prepared to maintain the current target range for the federal funds rate for longer, if appropriate."

Chair Powell's FOMC Press Conference, January 31, 2024.

China's Evergrande – Contagion Risks

Evergrande Center - Hong Kong

On Monday, January 29, the Hong Kong court issued an order for the winding up of Evergrande. This beleaguered Chinese company is the world's most indebted property developer. This ruling comes over two years after the real estate giant encountered a severe liquidity crisis, culminating in defaulting on its debts and filing for bankruptcy in the United States.

China Evergrande Group was founded in 1996. Over the years, it became one of China's largest and most well-known real estate developers, focusing on residential and commercial properties. Evergrande's success was attributed to its aggressive expansion strategies and a business model that involved heavy borrowing to fund rapid development.

Throughout the late 20th and early 21st centuries, Evergrande played a significant role in China's real estate boom. The company capitalized on the country's urbanization and the rising demand for housing, constructing numerous high-rise residential complexes and commercial projects across various cities. The scale and speed of its development projects were unprecedented, contributing to the company's rapid rise in the real estate sector.

However, in the mid-2010s, concerns about China's property market and the debt-fueled growth of companies like Evergrande began to surface. In 2021, Evergrande faced a severe liquidity crisis, struggling to meet its debt obligations. This led to a series of challenges, including protests by homebuyers, warnings from regulators, and a looming risk of default. Evergrande borrowed heavily to acquire land, develop properties, and expand its business rapidly. The company's debt reached unprecedented levels to more than $300 billion USD by the end of 2022, raising concerns about its ability to meet repayment obligations. Although it had a large inventory of unsold properties, the slowing real estate market raised concerns about Evergrande's ability to sell these assets to generate revenue. In July 2023, the company disclosed a combined loss of $81 billion for 2021 and 2022. By the first half of 2023, the company reported an additional loss of $4.5 billion. Besides, The Chinese government implemented measures to control the real estate market and curb excessive debt in the sector.

Evergrande, being a major player in real estate, was directly impacted by these regulatory changes, which restricted its ability to secure financing and sell properties. Faced with a myriad of challenges, Evergrande ultimately succumbed to its financial difficulties, culminating in its forced liquidation by January 19, 2024.

The liquidation of Evergrande raises many concerns that reverberate across various sectors in China. Financial markets face heightened instability as the real estate giant's massive debt defaults could trigger a ripple effect, impacting domestic and global investors and institutions. The property market is susceptible to disruptions, with the possibility of a glut in unsold inventory, leading to a downturn in prices and affecting homeowners and developers alike. The intricate web of Evergrande's business relationships with suppliers and contractors raises the specter of supply chain disruptions, affecting industries beyond real estate, such as construction materials and manufacturing. Moreover, the company's extensive employment footprint may result in job losses, increasing unemployment, potential social unrest, and economic deflation. Government intervention becomes imperative to stabilize the market, inject liquidity, and implement measures to prevent a systemic financial crisis. The overarching concern lies in the interconnectedness of Evergrande's financial troubles, posing a threat to both the domestic and global economic landscape. While the full impacts of Evergrande's liquidation remain uncertain and require observation in the near future, investors should vigilantly monitor the real estate market as a whole. This event is a crucial lesson for companies, urging them to glean insights and adopt prudent financial practices to navigate potential challenges in the ever-evolving business landscape.

Economic Reports Feb 5-9
Select Indices as of Feb 2

Advisory services offered through Sowell Management, a Registered Investment Advisor. The views expressed represent the opinion of Sowell Management. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and non-proprietary sources that have not been independently verified for accuracy or completeness. While Sowell Management believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Sowell Management’s view as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements. Investing in securities involves risks, including the potential loss of principal. While equities may offer the potential for greater long-term growth than most debt securities, they generally have higher volatility. International investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles, or from economic or political instability in other nations. Past performance is not indicative of future results.


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