March 4-8, 2024

Tactical Signal 9

Momentum continues to gain strength as the market broadens, indicative of the strength in positive investor sentiment. Our technical indicators and strategic positioning remain favorable (100%).

In February, the markets soared to new heights, with the S&P 500 index breaking records, surpassing the 5,000 mark with a remarkable 5.34% surge, bringing the year-to-date gain to an impressive 7.11%. Last week, the market saw further gains of 0.99%, buoyed not just by AI and weight loss themes but also by the robust performance of energy, industrials, and healthcare stocks, as evidenced by the S&P 500 Equal-Weighted index climbing by 1.17%.

Even in the ever-evolving technology sector, it witnessed a broadening of market breadth, as notable players like NVIDIA led the charge with a 4.39% gain. But the momentum didn't stop there; we saw a ripple effect across computer hardware and semiconductor stocks, with Dell (+37.90%), Broadcom (+7.93%), HP Enterprise (+2.98%), Qualcomm (+5.28%), Texas Instrument (+4.50%), among others, posting substantial gains. As the economy navigates through certain segments of slowdown, investors are gravitating towards quality growth stocks characterized by high ROE, positive earnings growth, and prudent leverage management.

Amidst this, there was a collective sigh of relief as the latest personal consumption expenditure measure ("PCE") showed a slight downtrend in inflation, easing concerns. However, there are cracks in the economy's strength as Durable Goods Orders declined by 6.1%, Construction Spending declined by 0.2%, Initial Jobless Claims rose above consensus to 215k, and UMich Consumer Sentiment slipped to 76.9.

While bonds have remained subdued amidst anticipation of interest rate cuts, a modest YTD gain of 0.47% last week offered a glimmer of positivity amid economic uncertainties.

Looking ahead, with over 76% of S&P 500 companies surpassing earnings expectations, the momentum appears robust as the markets step into March. This week, the focus will remain on economic health and job metrics, with Factory Orders, Unemployment Rate, and Participation Rate setting the stage for the March 19th FOMC meeting. As the nation gears up for Super Tuesday, where the Democrats and Republicans shape their policy narratives, such political dynamics will inevitably influence market sentiment, at least in tone, as we look forward.

"Inflation has eased notably over the past year but remains above our longer-run goal of 2 percent. Total PCE prices rose 2.6 percent over the 12 months ending in December; excluding the volatile food and energy categories, core PCE prices rose 2.9 percent. The lower inflation readings over the second half of last year are welcome, but we will need to see continuing evidence to build confidence that inflation is moving down sustainably toward our goal." 

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

Clouds on the Horizon – The Risks of Waging War


The S&P 500 is valued at approximately 27 times trailing twelve month's earnings, TTM, well above the historical median of roughly 18 times TTM. The S&P generated a return of 26.3% for all of 2023. The Index returned 11.7% in the fourth quarter of 2023 and about 7.11% in YTD 2024. The well above-average valuation and the highly favorable returns reflect the belief on the part of investors that the Fed is at or near the end of its effort to reduce inflation. Some data support a less optimistic outlook for Fed policies and geo-political events that should give rise to a cautious approach to asset allocation.

Liquidity began to expand in December of 2022. The rate of growth of the money supply is now positive, and the rate of growth has increased in recent months. The fight against inflation has ended effectively, the trend in interest rates notwithstanding. Over the last 50 years, the Fed's commitment to price stability has been half-hearted. This most recent episode is likely to provide no evidence to the contrary. Moreover, whatever the intensity of the Fed's commitment to price stability, a test of that commitment is on the horizon.

The Fed is about to be confronted with political realities that will present difficult choices. According to CBO estimates, the Treasury will be running deficits of about $1.7 trillion per year for the next ten years. The Fed will either persist in its effort to stabilize inflation or help finance the looming deficits. Irrespective of the Fed's choices, there will be likely episodes of economic instability. Inflation will re-emerge as a concern, or credit markets will tighten.

Events are unfolding, especially in an election year, which could increase the size of the deficit and create a greater demand for liquidity. Increased US involvement in the military conflicts in the Middle East and Ukraine would produce a substantial demand for funds and military supplies from the US. While the paths these conflicts will follow are difficult to forecast, there have been similar events in the past that might provide some insights into the potential impact a growing military involvement in these areas might have on the US economy. Currently, defense expenditures are about 2.7% of GDP. During the Korean War, defense expenditures were a bit over 11% of GDP. During the Vietnam War, expenditures were about 9% of GDP; during the Cold War, defense expenditures as a percent of GDP peaked at just under 6%; and during US military intervention in Iraq and Afghanistan, expenditures peaked in 2010 at 4.5% of GDP. Clearly, an increase in defense spending equal to even 2% of GDP would increase the projected deficits.

While the existing magnitude of the US involvement in the conflicts does not bring a major financial burden, the risk of an escalation in the burden should be part of any forecast of future economic and market conditions. Military conflicts can increase in scale at first slowly and then all at once. In 1960, there were about 900 military advisors in Vietnam. By the end of 1963, that number had risen to over 16,000. In 1964, the year of the Gulf of Tonkin incident, there were 23,000 American troops.

After Congress authorized the President to take measures to defend US forces in August of 1964, troop levels rose rapidly. In 1965, there were 184,000 troops in Vietnam. Troop levels peaked at 535,000 in 1969.

The costs of the Vietnam War, combined with the costs of ambitious social welfare programs, produced growing Federal budget deficits. In 1969, President Johnson moved Social Security "on budget" and created a "unified budget." The Social Security surplus was used to paper over the budget deficit. At the same time, budget deficits were increasing, the money supply was growing rapidly, and inflation rose to 6.4% annually in early 1970. By August of 1971, it became difficult for the Treasury to stand by its promise to buy and sell gold at a fixed price to foreign governments, and the so-called gold window was closed. Eventually, prices increased to more than 10% annually, interest rates were over 10%, and unemployment was above 10%.

The extent to which the US will become involved in any of these conflicts in the future is uncertain, as are the consequences of any involvement. However, the consequences of any escalation in the conflicts can produce far less favorable economic and financial market conditions than current ones. From 1965 to 1980, when real GDP growth slowed and inflation increased, the real rate of return on stocks was negative. While investors may feel uncomfortable analyzing the consequences of geo-political events, the enormity of the outcomes compels our attention.

Select Indices as of 3/1/24
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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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