Long(View) from London: “Where to Allocate -> US & EZ Small/Mid-Caps vs. Large Caps; PLUS UK Labour Market –> How Bad Is It?””

Key Quote: “The Next China Shock”

“David Autor (economics professor at MIT) & Gordon Hanson (economics professor at Harvard’s Kennedy School) lay out how China is, at least on some metrics, winning in the ‘innovation sectors’”

Source: Thursday’s ‘Daily Dose of Macro & Markets’ 17^th July 2025 “The Next China Shock”

Chart of the Week: China’s Technological Edge

FIG 1: Rank and share of the world’s most cited research in each field, by country

Source: NYT, 14^th July 2025, “We Warned About the First China Shock. The Next One Will Be Worse.”;

https://www.nytimes.com/2025/07/14/opinion/china-shock-economy-manufacturing.html

US/EZ Small & Mid Cap Equities –> BUY Case Brewing

Small and mid cap equities are increasingly becoming a focus of conversations with clients – and rightly so.

For the past 3 or so years (since the 2022 rate hiking cycle), money has been tight across Western economies. That has resulted in the absence of an industrial cycle, weak housing cycles (especially in the US), and a challenging business environment for small and medium sized businesses (see 2^nd July Monthly Asset Allocation report for further analysis: “US Small & Mid Caps: Buy Case Brewing A.k.a. (still) a Two Tier Economy”).

As a result small, mid & large cap earnings growth (across most of the West) has been largely non-existent. The UK stock market’s consensus forward earnings has been flat since 2022; in Europe it’s been the same; while Chinese earnings have shrunk since 2021 (indicative of their balance sheet recession dynamic) – FIG 8 in appendix.

The US large caps (specifically the large cap thematic and MAG7/IT stocks – more below) have been the exception, generating strong earnings growth. The MAG7’s collective net income, for example, almost tripled between Q2 2022 and the end of 2024 (from $59.7 billion to $152.2 billion). As a result, those stocks attracted the majority of the global money flows, became richly priced (NB the MAG7’s median PER ratio is 33x forward earnings), and grew to dominate the global stock market (i.e. in terms of market capitalisation - the MAG7, for example, now accounts for 32% of the US stock market, FIG 9 in appendix, and 20% of the global stock market). It’s also one of the key reasons the dollar was so strong (up until the start of this year).

Indeed, pretty much everyone we spoke to last year around the world owned Nvidia (and other MAG7 stocks), including people who never used to even own US stocks.

With global rate cutting cycles underway, though, that era (of the past 3 years or so) is starting to change. Money is starting to flow into other areas of the global stock market (i.e. other than just US large cap) and while no trends move in straight lines, this one looks like it’s just getting started and is likely to extend over a few years.