Source: Guojun Overseas Macro Research Author: Zhou Hao, Sun Yingchao Recently, the conflict between employment data has not brought a clearer direction to the market. Looking ahead, the market's attention has now shifted to this week's inflation data and the Fed's interest rate meeting. Due to the recent sharp drop in oil prices, the May CPI data should cool down to some extent, which will alleviate the market's concern about inflation. In terms of product structure, the operating income of products valued between 10 and 30 billion yuan were respectively 401/1288/60 million yuan.
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Key Takeaways

Recently, small and mid-cap stocks in the U.S. have demonstrated strong performance. The E-mini Russell 2000 index has surged quickly and has gained more than 10.5% since July 9, 2024. At the same time, the weekly return rate of the Russell 2000 and NASDAQ indices has rapidly expanded relatively, while the earnings of AI businesses of companies such as Tesla (TSLA US) and Alphabet (GOOG US) don't relieve market concerns. Under the influence of the risk-averse sentiment, funds have started flowing towards mid and small-cap stocks.

Since May 2024, the E-mini Russell 2000 index has shown a strong consistency with the Federal Reserve's expected interest rate cut. Small and medium-sized enterprises in the U.S. are more significantly impacted by high interest rates. Long-term high interest rates will lead to high operating costs for companies, and they do not possess the ability to entirely pass on the costs to consumers. Therefore, in the phase where the Federal Reserve's policy interest rate undergoes a trend change, the correlation between U.S. small and mid-cap stocks and the expected interest rate cut gradually strengthens.

The expectation of the Federal Reserve's interest rate cut and the further clarity of the U.S. election results are significant factors driving the U.S. small and mid-cap stocks upward. After the announcement of the CPI data for June, the market fully expected that the Federal Reserve would cut interest rates in September, and the pressure on mid and small-cap stocks was relieved following the decrease in interest rates. Additionally, due to Trump's TV debate and support following a shooting incident, mid and small-cap stocks are directly benefiting from the 'Trump trade'.

It is worth mentioning that the change in extreme positions may also be an important factor in pushing small and mid-cap stock prices upward. CFCT data indicates that since July, asset management companies and leveraged funds have rapidly adjusted their holding position strategies, and both have significantly increased their long positions in the Russell 2000. On July 16, the long positions of asset management companies and leveraged funds accounted for 59% and 41%, respectively, showing a substantial increase from July 2 (55% and 28%).

Looking forward, the US economy's unexpectedly high growth and imminent interest rate cuts from the Federal Reserve are expected to continue to release pressure on U.S. small and mid-cap stocks. The actual annualized quarterly growth rate for the U.S. real GDP in the second quarter of 2024 was recorded at 2.8%, far beyond market expectations. This implies that, even after two years of inflation soaring and the Federal Reserve raising interest rates rapidly, the foundation of the U.S. economy remains solid. Moreover, even though economic growth was higher than expected, the first rate cut by the Federal Reserve in September was not affected. Under this circumstance, the pressure on the numerator and denominator ends of U.S. small and mid-cap stocks are expected to continue to recover.

Main text

Recently, small and mid-cap stocks in the U.S. have demonstrated strong performance. The E-mini Russell 2000 index has surged quickly and has gained more than 10.5% since July 9, 2024. At the same time, the weekly return rate of the Russell 2000 and NASDAQ indices has rapidly expanded relatively, while the earnings of AI businesses of companies such as Tesla (TSLA US) and Alphabet (GOOG US) don't relieve market concerns. Under the influence of the risk-averse sentiment, funds have started flowing towards mid and small-cap stocks.

The continuous upward momentum of the US stock market since 2023 has mainly come from the significant rise in the stock prices of 7 large technology companies, and most US companies have not experienced significant rises in stock prices, and have even contributed negatively since entering 2024, with poor performance from small-cap US stocks.

Since May 2024, the Russell 2000 index and the expected US interest rate cuts by the Federal Reserve have shown strong consistency. The high interest rate policy of the Federal Reserve does not have a significant impact on technology giants. In terms of the company's growth cycle, they have already passed the stage of business expansion relying on financing and have outstanding "blood-making" ability. On the contrary, the impact of high interest rates on small and medium-sized US companies is more significant, and long-term high interest rates mean high operating costs for companies, and they do not have the ability to completely shift costs to consumers. Therefore, the correlation between small-cap US stocks and the expectation of interest rate cuts will gradually increase during the trend change phase of the Federal Reserve's policy rate.

The strengthening of the expectation of US interest rate cuts by the Federal Reserve and the further clarity of the results of the US presidential election are important factors driving the rise of small-cap US stocks. After the release of the US CPI data for June, the market fully traded that the Federal Reserve would cut interest rates in September, and the pressure on small-cap US stocks was eased by the expectation of lower interest rates. To some extent, the US CPI data for June has significant milestone significance, with a year-on-year growth rate of 3%, lower than the market expected value of 3.1%. More importantly, the month-on-month CPI in June was -0.1%, the first negative since 2020. Subsequently, Federal Reserve Chairman Powell also stated that there was no need to wait for the inflation rate to drop to 2% before starting to cut interest rates. As the path of interest rate cuts becomes clearer, the pressure on small-cap US stocks begins to ease, and the Russell 2000 index rises sharply in the short term.

In addition, the transformation of extreme positions may also be an important factor in driving up small-cap stock prices. The data from the Commodity Futures Trading Commission (CFCT) shows that before the release of the CPI data for June, the net positions of asset management companies for the Russell 2000 were relatively stable in the year, while leveraged funds continued to increase short positions. Since July, asset management companies and leveraged funds have rapidly adjusted their positions, both significantly increasing their long positions in the Russell 2000. On July 16, the long positions of asset management companies and leveraged funds were 59% and 41%, respectively, a significant increase from July 2 (55% and 28%).

It is worth mentioning that the shift of extreme positions may also be an important factor in boosting the rise of cni mid-small cap.index. According to data from the Commodity Futures Trading Commission (CFTC), asset management companies' net positions on the Russell 2000 were relatively stable year-to-date before the release of June CPI data, while leveraged funds continued to increase their short positions. Starting in July, both asset management companies and leveraged funds quickly adjusted their hold positions strategy, with a significant increase in long positions on the Russell 2000. On July 16, the long positions ratio of asset management companies and leveraged funds was 59% and 41%, respectively, which was significantly higher than on July 2nd (55% and 28%).

Looking ahead, the US economy is expected to continue to release pressure on US mid-small cap stocks due to better-than-expected growth and potential rate cuts by the Federal Reserve. Driven by consumer spending and growth in business equipment and inventory, the annualized seasonally adjusted actual GDP growth rate for Q2 in the US was 2.8%, higher than Q1's 1.4%, and much higher than the market's expected value of 2.1%. This means that even if inflation surges and leads to a rapid increase in interest rates by the Federal Reserve after two years, the foundation of the US economy remains strong. At the same time, despite unexpected economic growth, the expectation of the Federal Reserve's first rate cut in September has not been affected. Under these circumstances, the numerator and denominator pressures of US mid-small cap stocks are expected to continue to recover.

Editor / jayden