December sixteenth, two thousand twenty-four

I. Foundation 

resistance to change and hence greater dependability for the results shown in the past.

II. Insights 

Our Viewpoints and ideas on market.

On late-cycle trading: not a new cycle, but an extension of the current cycle

Federal Reserve rate cuts and stable business-cycle indicators will drive more balanced growth and performance across the U.S. equity market in 2025, but this balanced growth may be concentrated more in Large Caps than in small caps. Historical experience shows that sustained small-cap outperformance typically occurs in an Early Cycle Environment, accompanied by the end of the labor cycle and rate cuts of several hundred basis points; the current environment does not have these characteristics.

The pace of earnings growth is an important clue for determining where we are in the business cycle.

S&P 500’s EPS Growth typically bottoms at one of two levels, near 0%, or between -15% and -25%, while small caps are more volatile, with more pronounced swings in both troughs and peaks.

Chart: The current pickup in earnings growth starting from 0 is characteristic of a late-cycle extension

The key to determining which type of bottom forms is whether the labor cycle shocks the economy.

When the labor cycle involves rising unemployment, earnings troughs are usually deeper, as shown by the dashed circles in the chart above; when the labor market experiences no substantial shock (solid circles), the troughs are shallower.

The current Inflection Point (earnings growth turning point) has rebounded from near the zero line, indicating that it has not been weighed down by the unemployment cycle and suggesting that the current economic cycle has not ended but has continued along its expansion path. In other words, This is a Growth Acceleration after a “soft landing.”

However, it is worth noting that, given the continued tightness of the labor market, This renewed acceleration in earnings growth today may be a typical Late Cycle Extension, or late-cycle continuation.

Historically, accelerations in earnings growth during this kind of late-cycle phase have usually been driven by the distinctive forces of a particular cycle.

The boom in technology-equipment spending in the late 1990s drove earnings growth but did not persist as it spread through the economy; the rebound after the earnings trough in 2015 benefited from a global growth recovery fueled by China's large-scale fiscal stimulus and a boost from U.S. tax reform in 2017.

In the current cycle, the recovery in earnings growth depends more on a small group of Large Cap, Quality Names, which benefit from AI capital expenditures, cost reductions, and improvements in operational efficiency.

Chart: Reposting the chart from yesterday's Weekly Wrap

The trend in the ratio of the S&P 500 equal-weight index to the market-cap-weighted index is a typical illustration of this trend, and this ratio has consistently reflected late-cycle market characteristics over the past few years. Although the market rebounded this summer from its “recession scare” lows, the ratio has recently started falling again, suggesting that a broadening of earnings growth may be more a story for 2025 than something achievable in the fourth quarter of 2024.

Chart: Relative performance of equal-weighted indices has not shown sustainable growth

Looking at forward-looking indicators of earnings growth, EPS growth among small caps and lower-quality companies (Lower Quality Areas) has also bottomed, but its rebound has been markedly weaker than that of the S&P 500. This further confirms that we are still in a late-cycle environment:

At this stage, profits are harder for lower-quality companies to come by, with higher price levels, persistent labor-cost pressures, and rising real interest rates, the key question to answer is: can earnings growth at ordinary companies reaccelerate relative to that of others?

Most likely, yes, but the focus of earnings growth will still tilt toward Large Caps, and this growth may be more Idiosyncratic than the market consensus suggests, meaning it is better to focus on Quality Cyclicals than to chase lower-quality cyclical stocks，The latter's performance often depends on larger adjustments in interest rates and labor costs, and these conditions are not yet fully in place in the current macro environment.

The broadening of earnings growth across the market remains at an early stage. In the short term, the main drivers of the earnings recovery remain concentrated in high-quality names with advantages in pricing power, cost control, and efficiency improvements. Be alert to the relative disadvantages of lower-quality names stemming from structural constraints (such as high costs and access to funding), and prioritize allocating resources to companies that can generate excess returns through innovation and operating leverage in the current environment. This divergence is a typical feature of the late cycle.

Yesterday's Weekly Wrap on last week (if you haven't read it, you absolutely should!!)also discussed our concerns about current market breadth. In the late cycle, large caps are bound to benefit first as breadth broadens, If nothing else new emerges, the small-cap trade may be about done once this Trump-driven move runs its course.

2024.12.16

The historic rally in Chinese government bonds

Since 12, Chinese government bonds have become a global focus and staged a historic rally.

The 10-year government bond yield (CGB 10y) quickly broke below key support, successively falling below 2.0% and 1.8%, heading straight for 1.7%; the 30-year government bond yield also fell below the 2% threshold last Friday.

 Chart: As 12 begins, CGB yields and Repo IRS break through key levels, with a powerful rally

The rally began with the announcement of the interest-rate self-regulatory mechanism, with policy signals clearly indicating that monetary policy would shift toward “moderately accommodative”; subsequent Politburo and Central Economic Work Conference meetings further confirmed this stance, Before the meeting, we had already pointed out: rather than watching the policy text, keep an eye on the bond market as it resumes a one-way move.

Importantly, this rally differs in many ways from the move in 9.

In September, the market still had high hopes for fiscal policy, focusing mainly on fiscal stimulus, which led to bear steepening of the curve (long-term yields rose). This time, the move is driven purely by monetary policy, and expectations are now fully established that the 2025-year 7d OMO rate will be cut by RRR 50bps.

 Chart: The comparison between 10-year CGB yields and 7D OMO rates shows that the market expects more rate cuts

Another interesting development occurred between the end of 11 and the beginning of 12.

At the time, the CNH DF curve had corrected significantly; especially after Trump's election victory, the front end DF failed to convincingly break above its annual high.On 12 10, buying emerged during the London session and pushed the curve higher; T/N (Tom Next, meaning overnight swap) rose particularly sharply, and 12 11 then saw an unusual price move.

 Chart: The front end DF failed to substantially break YTD highs 

The unusual market move sparked broad buying interest.

The move was amplified by rumors:Chinese policymakers were reportedly considering allowing the renminbi to depreciate in 2025 in response to a resumption of Trump's tariffs. The news immediately sent USDCNH (the offshore renminbi exchange rate against the U.S. dollar) surging to 7.29, pushed T/N prices all the way up to +2, and caused the implied yield on short-term 1-month instruments to jump 80bps to 3.2%.

Put simply, what this means is Concerns about renminbi depreciation over these few days triggered urgent safe-haven positioning, renminbi funding became scarce, pushing up short-term funding costs (that is, T/N).

That evening, an official channel affiliated with the central bank issued a clarification, emphasizing that “the renminbi exchange rate has a stable foundation.” The USDCNH exchange rate then fell back, but the DF curve remained firm.On 12 12 and 13, the front-end curve tested its annual highs twice but failed to break through either time; profit-taking then emerged, and the curve quickly corrected.

Chart: The offshore-onshore 1y swap spread has widened to its April highs

However, T/N remained firm, briefly touching +12 during the London session, reflecting a further widening of the market's disagreement over short-term renminbi funding conditions, while the rise in T/N was driven more by the Politburo meeting, whose positive signals attracted overseas capital inflows into Chinese equities.

But as Chinese equities weakened after the Central Economic Work Conference ended, sentiment turned down and capital flows slowed; T/N fell back to around +0.5, and the DF curve declined further.

T/N fluctuations reflect short-term supply and demand changes in the renminbi funding market, but this round was influenced not only by exchange-rate rumors; it was also closely tied to capital flows in Chinese equities. When expectations of a weaker renminbi emerge and inflows into the equity market slow, T/N fluctuates significantly, reflecting rapid shifts in market sentiment.

The final question is whether the rate market has rallied too far. How should we view the outlook?

The market's point of disagreement is this:On the one hand, bond-market yields have fallen rapidly in the short term 20-30bps and are already near historical lows; some investors are beginning to worry that the PBoC will suppress the one-way move (as it did this summer). On the other hand, the low-rate policy stance is clear, and room for future rate cuts remains.

Historically, the spread between the 10-year CGB yield and the 7d OMO rate is usually around 50bps.

If the 2025-year 7d OMO rate is indeed cut by 50bps, then 10-year CGB still has some room to fall, but the risk-reward at current levels is no longer as attractive as before.The bond market still has some room to rise, but the pace of the short-term rally has been too fast, and pressure to take profits is building. Chasing the rally at current levels calls for greater caution; wait for a better entry point.

2024.12.17

III. Market Pulse 

Our latest Comments on the economic and market environment

Note: All content in this article is for reference only and does not constitute investment advice or serve as a basis for any laws, regulations, or regulatory policies. Investors should not use or rely on this information as a basis for decision-making.