Financial and Economic News: January 31, 2024

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Iran-Backed Missile Makes Economic Impact

This week, we’re starting off with the implications of the missile strike that sadly killed three US servicemen in Jordan over the weekend. President Joe Biden has disclosed that he's made a decision on how to respond to the attack. While blaming Iran for supplying the militants with weaponry, Biden emphasized a desire to avoid escalating the conflict in the already tense region. The National Security Council suggests a potential tiered approach to the response, indicating multiple actions over time. However, some in Congress are advocating for retaliatory strikes, even suggesting hits on Iranian territory which would certainly raise the risk of broader conflict. The situation could have far-reaching impacts depending on how Biden chooses to respond, and may influence the stability of the Middle East, as well as the global economy at large. Given that this is part of the Houthi’s broader attacks on shipping vessels in the region, the situation has already been impacting global trade routes. However, with this latest strike increasing tensions in the area, there are renewed concerns that it will likely lead to price hikes on imported goods, including oil, potentially undermining Biden’s efforts to control inflation at home. As always, there’s a delicate balance of navigating geopolitical challenges because of their impact on foreign policy and also our day to day lives. 

Evergrande Nevermore

Keeping with international news, Hong Kong Judge Linda Chan's recent decision to issue a liquidation order for China Evergrande Group marks a pivotal moment in the unfolding property crisis gripping China. Once a symbol of China's robust property market, Evergrande's staggering $300 billion debt has led to a collapse that is reshaping the economic landscape. As this liquidation process unfolds, global investors are closely watching and scrutinizing the impact on foreign capital in China. With the majority of Evergrande's assets located in mainland China, the court-appointed liquidator is facing substantial challenges, given that Hong Kong’s legal jurisdiction isn’t recognized there. But beyond the legal intricacies, Evergrande's collapse resonates globally, influencing investor sentiment and potentially triggering a domino effect on other pending cases within the Chinese property sector. As China's economy continues to slump, the collapse of this once-mighty financial giant raises concerns about the macroeconomic ramifications and broader repercussions for the country’s already suffering property sector.

China Races to Rescue Economy

While we’re in China, the country’s policymakers are ramping up efforts to revitalize the economy and stabilize slipping markets in the face of challenges from the property crisis, deflation, and weak consumer confidence. Their strategies involve injecting more long-term cash into banks, tightening rules on share lending for short selling, and broadening developer access to loans. Despite these moves, the CSI 300 Index is down 4% in 2024, signaling investors' cautious outlook. To breathe life into the economy, the People's Bank of China has reversed course and now plans a substantial 0.5 percentage point cut in the reserve requirement ratio (RRR), injecting $139 billion into the market. And while it sounds counter-intuitive, given the property crisis, the Chinese government is encouraging real estate purchases and easing access to investments in the Greater Bay Area. While China has been rocked by these economic developments, the impact extends far beyond their borders. Global investors are keenly observing these actions as China's economic health significantly influences the global economy, as they may reshape dynamics in real estate and lending conditions.

Naked & A Fraud: South Korea Exposes Short Sellers

Wrapping up our stories in Asia, the Financial Supervisory Service (FSS) in South Korea recently unveiled a significant discovery—$41 million of illegal naked short selling on domestic stocks by undisclosed global banks. This practice, which involves selling shares without borrowing them first, breached regulations over several months in 2022 and 2023. Although the FSS hasn't named the banks involved, it has indicated swift penalties will follow. These revelations are especially significant, given South Korea's surprising November decision to impose a complete ban on all forms of stock short selling, in an attempt to rein-in these illegal practices and weed out those responsible. The move was met with mixed reactions; while retail investors applauded the measure for its potential to restore market fairness, others perceived it as politically driven. Looking at the bigger picture, the implications extend well beyond the banks' potential penalties. The FSS's focus on uncovering and addressing illicit practices in the financial markets, particularly related to naked short selling, signifies a broader crackdown and underscores a commitment by international regulators to maintain market integrity and fairness.

U.S. Real Estate Resurgence?

Here at home, mortgage rates are predicted to drop to 5.5% by year-end, marking a welcome shift from the recent climb to 6.69%. The Federal Reserve's signal of potential interest rate cuts adds fuel to the optimism, with a majority of respondents to a recent Bloomberg survey viewing real estate as a more attractive investment compared to 2023. This forecast comes on the heels of a challenging period for the housing market, grappling with the lowest sales figures in nearly three decades due to soaring borrowing costs. While this bodes well for folks looking to buy homes, the commercial sector faces ongoing challenges, particularly in selling office space. However, there is a growing consensus among investors to convert vacant offices into residential properties– a strategic response to the hurdles of falling property values and refinancing complications. Investors eye opportunities like these in premium buildings as they navigate the aftermath of the commercial real estate downturn, and this dynamic shift underscores a broader trend that sees market players exploring bold solutions to adapt to the new real estate landscape.

Morgan Stanley Bullish on Banks

Meanwhile, Morgan Stanley analysts are expressing optimism about major US banks—including Goldman Sachs, Citigroup, and Bank of America—as they anticipate more favorable regulatory changes for higher capital levels. The proposed changes, known as the Basel 3 Endgame by the Federal Reserve, initially mandated a nearly 20% increase in the capital major banks set aside. However, growing opposition from within the banking sector has prompted speculation that the Fed may consider concessions. Morgan Stanley's analysts suggest that if the final rules are less harsh than the current proposal, it could pave the way for a substantial increase in buybacks. Currently, large-cap banks possess unprecedented levels of excess capital, amounting to $154 billion, which provides them room for potential shareholder-friendly initiatives. As a consequence of Morgan Stanley’s positive outlook on these major banks, Citigroup shares saw a 5.5% surge, Goldman Sachs rose by 1.7%, and Bank of America climbed 3.5%. We’ll have to stay tuned and see how things unfold over the course of the next few months, particularly with possible mergers and acquisitions on the horizon.

Big Tech’s Big Earnings Week 

This week holds significant importance for markets, particularly Big Tech stocks, according to JPMorgan's Marko Kolanovic. The upcoming earnings reports from major tech giants like Apple, Microsoft, and Alphabet will be crucial in determining whether their current valuations are sustainable. Investors are banking on substantial earnings growth, as they are anticipating interest rate cuts sooner than predicted by the Federal Reserve. Kolanovic emphasizes that the market is heavily reliant on tech-driven gains, especially from the Magnificent Seven growth companies, which hold a substantial premium over the S&P 500. As these companies report earnings, their performance will almost certainly shape the broader market trends. But while investors are optimistic about tech earnings, JPMorgan still holds a more cautious outlook on the overall U.S. equities market. Kolanovic predicts a potential drop in the S&P 500 to 4,200 by the end of the year, making it one of the most bearish forecasts among Wall Street firms. Kolanovic also points out the potential challenges ahead, including firmer core inflation in the first half of 2024, which may be currently undervalued in equities and credit markets. 

No Room For Roomba at Amazon

Speaking of Big Tech, Amazon made a strategic move this week by withdrawing its planned $1.4 billion acquisition of iRobot, the company behind the Roomba vacuum. This abrupt decision follows clashes with European Union regulators who were expected to reject the deal. As a result, iRobot’s CEO has stepped down, marking a significant development for the struggling company. In response to the deal's termination, iRobot will undergo a restructuring plan, cutting 31% of its workforce. This move demonstrates the heightened scrutiny faced by major tech players as they try to expand their influence - as regulators seek to prevent them from acquiring too many startups and stifling competition. The decision also underscores the challenges tech giants encounter in navigating current regulatory climates in the US and Europe, potentially impacting their ability to complete future acquisitions. While Amazon is set to pay a $94 million termination fee to iRobot, the termination frees the tech giant from dealing with the financial struggles faced by the company, which has seen declining sales and financial losses in recent years. Overall, this development signals that large tech companies may face increasingly challenging conditions in the years ahead.

Reddit Preps for IPO
Now some of you might not have heard of Reddit, but I’m sure your kids know all about it. This week, we learned that the social media platform is gearing up for its initial public offering (IPO) and, after initial talks with investors, it’s contemplating a valuation of at least $5 billion. This estimate indicates a more cautious approach compared to its 2021 fundraising, where Reddit achieved a valuation of $10 billion. The IPO's success hinges on various factors, including market conditions and Reddit's prominence in the meme-stock era. The platform, famous for the WallStreetBets forum that influenced stock market dynamics, has gained over 70 million daily active visitors in the last few years. As the discussions around the IPO continue, the final valuation target and timing may change. The contemplated $5 billion valuation highlights a broader trend in the tech industry, signaling a departure from the lofty private funding valuations seen in previous years. 

Musk’s Neuralink Reaches Major Milestone

Finally, it wouldn’t really be another week without news on Elon Musk. His Neuralink company, which we covered a few months ago, has reached a pivotal moment by successfully implanting its brain-computer interface device into a human patient-WHAT? It’s true-this breakthrough follows earlier approvals from the FDA for Neuralink to conduct human trials. The first product, smartly named "Telepathy," aims to empower individuals, especially those with limb disabilities, to control devices like phones and computers using their thoughts. It sounds like science-fiction, but this development is a major step towards Musk's vision of integrating human minds with technology. Although Neuralink's success with animal testing has raised ethical concerns, its progress positions the company at the forefront of the emerging brain-computer interface sector. While the initial use cases target those with physical disabilities, the broader implications suggest a potential future where humans seamlessly interact with technology through mere thoughts. But let’s not get ahead of ourselves, as the road to a commercial brain implant remains challenging and requires very careful consideration of ethical, safety, and regulatory aspects. Despite the excitement surrounding this achievement, it's crucial to avoid overhyping this technology, as Neuralink even emphasizes that an approved device is still years away. So as a business man, I’m impressed and amazed by the scope of the company’s ambition. But as a regular consumer, I’m a little terrified. We’ll see where it goes!