US's Soft landing = Giants take control + Small caps lose out?

In last week's strategy weekly report "Has the Leading Engine of American Consumption Leaked, Can We Still Trade Soft Landing?" mentioned the US residents' income and expenditure statement, stating that as the absolute pillar of US economic growth, residents' consumption expenditure on one hand depends on the marginal changes in the largest source of income - overall social employment, and on the other hand, on the trend of savings rate changes.

Last week, the latest US resident employment data for June was released, with economic trend signals hidden behind this data.

I. US Labor Force: Supply "External Cycle" + Demand "Internal Cycle" = Economic Growth Positive Cycle

If we take 2018 as a watershed, the US labor market was relatively abundant before this time, but after 2018, demand gradually began to slightly exceed labor supply. However, until before the epidemic, the US labor market can only be described as tight balance, and the supply gap is not large.

However, the epidemic in 2020 triggered two major earthquakes in the labor market: a. As one of the main sources of US labor supply, Trump's policy of excluding immigrants resulted in almost a halt in the inflow of immigrants to the US; b. The epidemic caused some people to retire early, and the labor participation rate almost permanently dropped from over 63% to the current range of around 62.5%.

The result of these two resonating factors is that after the epidemic, a huge gap between labor supply and demand has been formed, which can only be filled by a. high interest rates suppressing corporate recruitment demand; b. relaxing immigration to fill the gap. The Dolphin originally estimated that this process should have ended in the second half of last year.

In fact, the US relied on the influx of immigrants to provide external circulation in terms of supply, while in terms of domestic demand, with the addition of 200,000 to 300,000 new non-agricultural jobs every month, which not only filled job vacancies and tilted towards blue-collar jobs, behind each additional job and each additional income, residents' consumption demand also expanded. The external circulation of labor force also fed the internal circulation of residents' consumption demand.

Under the strong domestic demand of residents, the demand for corporate recruitment has not weakened rapidly, but has been hesitant and fluctuating, leading to the huge labor shortage brought about by the epidemic only truly returning to a slightly deficient state before the epidemic by mid-2024, rather than the third and fourth quarters of 2023 as originally estimated by the Dolphin.

II. After the turning point of supply and demand, how long can employment continue to drive the economic positive cycle?

Although this process is progressing very slowly, it has finally arrived. For this reason, the Dolphin mentioned in last week's weekly report that it is difficult for the US employment to maintain monthly new non-agricultural employment of 250,000 to 300,000 in the future, and employment data is unlikely to significantly exceed market expectations again The latest US labor data for June paints a picture as follows:

1). 210,000 non-farm payroll jobs were added, basically matching the potential labor force population growth of 190,000 in the US each month (including labor force and non-labor force), no longer significantly exceeding previous months;

2). White-collarization + bureaucratization of new jobs: Looking in detail at the distribution of non-farm employment, if divided into enterprises and government units, in the past two months, government units, especially local governments, have had strong demand for recruitment, while enterprises have been relatively flat.

Taking a closer look at new hires in the business sector, starting with commodity production: the only industry with good recruitment is construction, in the manufacturing industry, apart from motor vehicle manufacturing in durable goods and food manufacturing in non-durable goods, other recruitment demands are relatively low.

Next, looking at the service industry, which is the most labor-intensive: the medical and education sectors continue to perform well as usual. Other sectors such as terminal retail overall are weak, already in net layoffs; transportation is slightly better, mainly relying on airplanes and ground transportation within cities.

The biggest change and contrast here is between blue-collar and white-collar service employment:

a. In finance, securities & insurance, professional services such as legal, accounting, construction engineering, design, computer, management, research and development, advertising, and even film, sports, gambling, and other white-collar positions are all in a net hiring state.

b. Temporary employment in professional services, travel bookings, and even previously in high demand recruitment in catering services have all seen net layoffs.

Obviously, as the labor supply and demand tend to balance, white-collar employment, driven by the new technological wave, has once again entered an investment phase for the giants, no longer laying off but turning to recruitment, white-collar positions are returning, while the proportion of blue-collar positions is marginally decreasing (possibly due to excess savings in the lower levels of society), wealth is once again beginning to be redistributed towards the middle class and above, corresponding to two results:

a. The hourly wage growth rate for private sector employment in the US is still on the rise, with a 0.3% month-on-month nominal wage growth in June, falling into a comfortable zone of neither high nor low;

b. White-collar vs blue-collar: as the cake is redistributed, can the overall savings rate in society continue to decline?

As mentioned by the Dolphin, behind every job and salary paid by a company to its employees, there is also corresponding demand from residents. When this wealth of wages + asset appreciation tends to concentrate more towards white-collar workers, and the blue-collar workers with lower savings receive less marginal benefits, it is worth questioning whether the overall savings rate in society will continue to decline. Over the past three months, the savings rate has risen for three consecutive months

3) Continuous Decline in Employment Numbers: When the U.S. Department of Labor announces the non-farm employment positions of the previous month each month, it will provide the number from the month before. Usually, there is a deviation between the initially announced number and the revised number announced the following month.

However, in recent months, the data has generally shown a downward deviation. For example, the non-farm employment number initially announced for April was 175,000, but the revised number for the following month became 165,000. The revised number for May was even more surprising, with a direct reduction of over 50,000 people, mainly concentrated in the food and beverage services within the accommodation sector. The employment in the service industry, especially in blue-collar concentrated services, is weakening.

In addition, another forward-looking indicator that corresponds to this—Service Industry Business Activity PMI—plummeted sharply in June. Key indicators such as business activities and new orders have declined significantly, although this indicator has experienced high volatility in the past, so whether it is noise needs to be observed. Considering that among the core components of current inflation, the certainty of commodity-based inflation, if service activities also decline, the certainty of the inflation decline trend will increase.

In summary, as of June, economic indicators such as PMI, employment, and wages all point to the momentum of economic growth gradually slowing down, but not slowing down to the extent that it raises substantial concerns about a recession. Therefore, the U.S. dollar and U.S. bond yields have fallen from their highs, but equity assets are still rising under the expectation of interest rate cuts.

III. Focus on Marginal Changes in Liquidity

Although Dolphin previously mentioned that the Federal Reserve's significant slowdown in quantitative easing has eliminated concerns about market liquidity this year, there have indeed been no major issues with liquidity recently.

However, two points still need attention: a) The U.S. annual deficit budget has increased as of October; b) The Federal Reserve did not net increase debt at the end of June, and the TGA account balance target still has $100 billion to be replenished, so it is not ruled out that the Treasury's debt issuance efforts may increase in the future.

Since the plan mainly focuses on short-term debt financing and will not add interest-paying medium and long-term debt, the additional debt is likely to be provided by consuming the $800 billion balance of reverse repurchase agreements. However, it is not ruled out that this may also deplete bank reserves.** In other words, under the current circumstances, reverse repurchase may have difficulty providing additional liquidity for equity assets.

With funds gradually becoming stockpiled, funds may further concentrate on high-quality assets, rather than experiencing a comprehensive rise in scattered stocks, small-cap stocks like the Russell 2000, and virtual assets as seen at the beginning of the year.

IV. Portfolio Rebalancing and Returns

Last week, Dolphin Portfolio did not rebalance. By the end of last week, the portfolio's returns increased by 2.2%, outperforming the SSE 300 (-1%), S&P 500 (2%), MSCI China (0.7%), and Hang Seng Tech Index (1.2%).

From the start of the portfolio testing to the end of last week, the absolute return of the portfolio was 34.4%, with an excess return compared to MSCI China of 57.6%. From the perspective of asset net value, Dolphin Portfolio's initial virtual assets of $100 million have now risen to $139 million.

V. Individual Stock Profit and Loss Contribution

As Dolphin Portfolio tends to select stable high-quality assets in equity investments, the portfolio easily outperforms when funds flow back to high-quality assets. Last week, the stocks with higher weightage in Dolphin Portfolio such as Meituan, Amazon, TSMC, and Facebook showed considerable gains, while the few remaining underweighted consumer stocks are still in a pullback phase, but the overall impact is minimal.

VI. Portfolio Asset Distribution

The Alpha Dolphin virtual portfolio holds a total of 20 individual stocks and equity-type ETFs, with 5 core holdings and the rest being underweighted equity assets, along with gold, US bonds, and US dollar cash.

As of the end of last week, the asset allocation and equity asset weightage of Alpha Dolphin are as follows: