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

Fed 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 to determining which stage of the business cycle we are in.

S&P 500’s EPS Growth typically bottoms at two levels—near 0%, or between -15% and -25%; small caps have a wider range of fluctuations, with more pronounced swings in their troughs and peaks.

Chart: The current Earnings Growth Picking Up began in 0, a feature 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 includes rising unemployment—as in the dashed circles in the chart above—earnings troughs are usually deeper. If the labor market does not experience a substantial shock, as in the 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 dragged down by the unemployment cycle and that the current economic cycle has not ended but has continued along its expansion path. In other words, This is Growth Acceleration following a “soft landing.”

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

Historically, earnings growth acceleration of this kind in the late cycle has usually been determined by the unique drivers of a particular cycle.

The overheating of technology equipment spending in the late 1990s drove earnings growth but failed to 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 rebound in earnings growth depends more on a small group of Large Cap, Quality Names, which benefit from AI capital spending, cost reductions, and improved operational efficiency.

Chart: Reuse the chart from yesterday’s Weekly Wrap

The ratio of the S&P 500 equal-weighted index to its market-cap-weighted index is a typical illustration of this trend, a ratio that 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 to decline again, indicating that a broadening of earnings growth may be more of a 2025 story than something achievable in the fourth quarter of 2024.

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

Forward-looking indicators of earnings growth show that EPS growth among small caps and lower-quality companies (Lower Quality Areas) has also bottomed out, but its rebound is clearly weaker than that of the S&P 500. This further confirms that we remain in a late-cycle environment:

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

Probably, but the center of gravity for earnings growth will still lean toward Large Caps, and this growth may be more Idiosyncratic than the market consensus implies, meaning it is better to focus on Quality Cyclicals than to chase lower-quality cyclical stocks，The latter’s performance often depends on greater adjustments in interest rates and labor costs, and these conditions are not yet fully in place in the current macroeconomic environment.

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

Yesterday’s Weekly Wrap on last week (if you haven’t read it, you absolutely should!!)also discussed our concerns about current market breadth. A late-cycle environment means that large caps will certainly be the first to benefit from any broadening, If nothing else new emerges, small-cap trading may have largely run its course after this Trump-driven move.

2024.12.16

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 decisions.